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PAM 204 PS #6
#1)
(7 points)
Suppose that there are only two time periods (working life and retirement).
Suppose that
Fred’s income during his working life is Y, and that Fred initially has a positive level of
savings.
Suppose that the tax on interest income is initially t and the retirement savings
subsidy parameter is initially ρ
1
(all savings are subsidized).
Suppose now that the
government
decreases
the subsidy to retirement savings (retirement savings subsidy
parameter now equals ρ
2
, all savings are still subsidized) and the income effect dominates
the substitution effect.
Will Fred save more or less?
Demonstrate your answer with a diagram involving budget constraints (C
R
plotted against
C
W
) and indifference curves.
In your diagram, give the values of the endpoints of your
budget constraints and the slopes of your budget constraints.
#2)
(7 points)
Suppose that there are only two time periods (working life and retirement).
Suppose that
Joe’s income during his working life is Y (>$4000), and that Joe’s savings initially equal
$2000.
Suppose that initially the tax on interest income is t, the retirement savings
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This note was uploaded on 03/30/2008 for the course PAM 2040 taught by Professor Lewis during the Fall '07 term at Cornell University (Engineering School).
 Fall '07
 LEWIS

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