Reference no: EM133196377
Assignment:
Question 1. Consider the two-period model of consumption behavior in the presence of fiscal policy. Let y* denote pre-tax income, T denote lump-sum taxes, and y = y• - T denote after-tax income. As long as we use after-tax income (y, not y•), the consumer's budget constraints are as before. Suppose that y• 1= 90, a1 =10, y•2 = 180 and r = 20%. The government's budget constraint is very similar to the consumer's in that the present value of the government's expenditures must equal the present value of its tax revenues: g1 + g2/(1+r) = T1 + T2/(1+r).
Suppose initially that g1 = 20 and g2 = 24.
A. Suppose that T1 = g1 and T2 = g2 What are y1 and y2? What is the present value of the consumer's lifetime after-tax resources (PVLR)?
B. Suppose instead that T1 equals 10. Show that if g1 and g2 do not change, T2 must now equal 36. What is the consumer's PVLR now?
C. Suppose that gi increases by 10, from 20 to 30. What will the consumer's PVLR be now? (Hint: Although it isn't necessary, you can assume that T1 = g1 and T2 = g2.)
Question 2. In the February 24, 2003 edition of Business Week, Robert J. Barro discusses President Bush's proposed tax cuts:
"One attraction of tax cuts and deficits is that they starve the government of revenue and thereby promote spending restraint. This worked particularly well in the 1980s. The Reagan tax reductions were a proclamation that the growth in the government had to stop-and, with something of a lag, that happened from the mid-1980s through the 1990s."
For the questions below, you should assume that the proposed tax cuts are lump sum.
A. Suppose first that Professor Barro's prediction is wrong: the government does not change its purchases of goods and services in response to the tax cuts. Under this scenario, how would the proposed tax cuts affect equilibrium saving/investment and the equilibrium real interest rate? You should assume that the Ricardian Equivalence Proposition is true. Graphs are useful but not necessary.
B. Now suppose that Professor Barro's prediction is correct: the tax cuts force the government to reduce its future (but not current) purchases of goods and services. Under this scenario, will the tax cuts increase or decrease the willingness of consumers to save? Briefly explain. Although it is not necessary, you can assume that consumers are forward-looking and aware of the government's budget constraint.
C. Using graphs, show how the savings changes you described in part (B) affect equilibrium saving/investment and the equilibrium real interest rate.
Question 3. Hula hoop fabricators cost $100 each. The HH Company must decide how many of these machines to buy for the upcoming year. The number of hula hoops that HHC expects to produce at each level of the capital stock is:
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Number of Fabricators
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Number of Hula Hoops
Produced per Year
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Marginal Revenues
(Dollars per Year)
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0
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0
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NA
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1
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90
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2
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150
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3
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190
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|
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4
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220
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5
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240
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6
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250
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Hula hoops have a real value of $1 each. HHC has no costs beyond fabricators.
A. Find the expected future marginal product of capital (in dollars) for each level of capital.
B. If the real interest rate is 10 percent per year and the depreciation rate of fabricators is 20 percent per yare, what is the user cost o capital (in dollars per fabricator per year)? Assuming that there are no taxes, how many fabricators should HHC buy?