Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

In the current period, a consumer gets an endowment y and pays lump-sum tax t. In the future period, the consumer is endowed with y'

In the current period, a consumer gets an endowment y and pays lump-sum tax t. In the future period, the consumer is endowed with y' and faces the lump-sum tax of t. The consumer can borrow at rate r1 and lend at the rate r2 , where r1

(i) Suppose that the rate at which consumers can lend got increased to r2 , so r1=r2 . That is, borrowers and lenders face the same rate. How does this increase affect the optimal choice of consumption (in the current and future periods) and savings for the consumer? Illustrate and explain how income effect and substitution effect matter for your answer for both lenders and borrowers.

(ii) Now, suppose that the rate at which consumers can borrow got decreased to r1 , so r2=r1. That is, borrowers and lenders face the same rate again, but now the lower rate. How does this increase affect the optimal choice of consumption (in the current and future periods) and savings for the consumer? Illustrate and explain how income effect and substitution effect matter for your answer for both lenders and borrowers

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Bank Management

Authors: Timothy W Koch, Mark S Cracolice

7th Edition

1111804265, 9781111804268

More Books

Students also viewed these Economics questions