1. Consider a household in the two-period consumption-savings model with well-behaved preferences over period-1 and -2 consumption given by u(c1, c2). Suppose that interest income in period 2 is taxed at a constant rate of 7. Assuming no initial endowment of wealth, A0 = 0, and the terminal condition A2 0, the household has the following nominal lifetime budget constraint: = Pic+ P2C2 (1+i(1 - Ti)) Y2 = Y₁ + (1+i(1 - Ti)) (a) Using indifference curve analysis, graphically locate the optimal choice (c1, c2). Label slopes and intercepts on your graph. (b) Write down the household's intertemporal optimality condition in terms of the gen- eral utility function. (c) In the United States, interest income received by households is taxed at a positive rate (i.e. > 0) while interest income paid by households is not taxed (i.e. T₁ = 0). Suppose legislators propose complete elimination of this tax. Use economic logic and your answer from part (b) to explain how this policy change would (if at all) affect the optimal level of private saving in period one for the following types of households: i. Net borrowers ii. Net savers for whom the substitution effect dominates the income effect on c₁ iii. Net savers for whom the income effect dominates the substitution effect on c₁
1. Consider a household in the two-period consumption-savings model with well-behaved preferences over period-1 and -2 consumption given by u(c1, c2). Suppose that interest income in period 2 is taxed at a constant rate of 7. Assuming no initial endowment of wealth, A0 = 0, and the terminal condition A2 0, the household has the following nominal lifetime budget constraint: = Pic+ P2C2 (1+i(1 - Ti)) Y2 = Y₁ + (1+i(1 - Ti)) (a) Using indifference curve analysis, graphically locate the optimal choice (c1, c2). Label slopes and intercepts on your graph. (b) Write down the household's intertemporal optimality condition in terms of the gen- eral utility function. (c) In the United States, interest income received by households is taxed at a positive rate (i.e. > 0) while interest income paid by households is not taxed (i.e. T₁ = 0). Suppose legislators propose complete elimination of this tax. Use economic logic and your answer from part (b) to explain how this policy change would (if at all) affect the optimal level of private saving in period one for the following types of households: i. Net borrowers ii. Net savers for whom the substitution effect dominates the income effect on c₁ iii. Net savers for whom the income effect dominates the substitution effect on c₁
Chapter17: Capital And Time
Section: Chapter Questions
Problem 17.2P
Related questions
Question
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
Step by step
Solved in 5 steps with 13 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, economics and related others by exploring similar questions and additional content below.Recommended textbooks for you
Exploring Economics
Economics
ISBN:
9781544336329
Author:
Robert L. Sexton
Publisher:
SAGE Publications, Inc
Managerial Economics: A Problem Solving Approach
Economics
ISBN:
9781337106665
Author:
Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Publisher:
Cengage Learning
Exploring Economics
Economics
ISBN:
9781544336329
Author:
Robert L. Sexton
Publisher:
SAGE Publications, Inc
Managerial Economics: A Problem Solving Approach
Economics
ISBN:
9781337106665
Author:
Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Publisher:
Cengage Learning