Suppose there are two consumer groups of the same size in a population, constrained and unconstrained. The constrained consumers have a kinked budget constraint while the unconstrained consumers do not have sufficient collaterisable wealth to support the amount of borrowing they would like to do. The government decides that it will tax each constrained consumer by an equal amount in the current period and distribute the tax revenue equally among the unconstrained consumers as transfers.

a)Take the market real interest rate as given and determine the effect of the redistribution by the government on the total demand for consumption goods in the current period and in the future period. (Only determine the next effects on the demand for consumption goods, given the real interest rate.) (12 marks)

b)What do the results tell you about a fiscal policy aimed at redistributing income toward those who will tend to spend more of it? (4 marks)

c) Determine an efficient tax policy. This will be the tax policy that relaxes the limited commitment constraint for consumers. (4 marks)

d) Discuss your results in parts (a) and (b). (10 marks)