When they go to the bank, the clerk explains that credit markets do not really work like Marshall thinks. In particular, in the case of Marshall and Lily, given Lily's past as a shopaholic, the interest rate they will be charged if they want to borrow (rB) will be much higher than the interest rate the bank would pay to a saver (rL ).

Write down the new intertemporal budget constraint and draw it in a new diagram. What is the maximum amount they can borrow? Would you expect any difference in the optimal choice of a borrower with respect to your answer in question b? Explain. (7 points] The government is launching a new program to help young couples purchase their rst house. called the Don't lGet Married program {the government has a weird sense of humor). Assume the government never defaults on its debt. Therefore, it borrows money at 11. Each couple will get a tax cut of 0.5 in the current period if they decide to borrow money and buy a house, but taxes will increase in the second period by an amount that keeps the government intertem poral budget constraint unchanged (i.e. 0.5(1 + 11)). How does the intertemporal budget constraint change? What would be the effect of the tax cut on the optimal choice of Marshall and Lily? How is this related to the Ricardian equivalence? (8 points]