HW9_sol - Answers to Textbook Questions and Problems b....

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184 Answers to Textbook Questions and Problems than the consumer who is not constrained—that is, the marginal propensity to consume is higher for a consumer who faces a borrowing constraint. Therefore, fis- cal policy is more potent with binding borrowing constraints than it is without them. b. Again, consider a two-period Fisher diagram. The announcement of a future tax cut increases Y 2 . Figure 17–9(A) shows the effect of this tax cut on a consumer who does not face a binding borrowing constraint, whereas Figure 17–9(B) shows the effect of this tax cut on a consumer who is constrained. The consumer who is not constrained immediately increases consumption C 1 . The consumer who is constrained cannot increase C 1 , because disposable income has not changed. Therefore, the announcement of a future tax cut has no effect on con- sumption or aggregate demand if consumers face binding borrowing constraints: fiscal policy is less potent. 5. In this question, we look at how income growth affects the pattern of consumption and wealth accumulation over a person’s lifetime. For simplicity, we assume that the inter- est rate is zero and that the consumer wants as smooth a consumption path as possible. a. Figure 17–10 shows the case in which the consumer can borrow. Income increases during the consumer’s lifetime until retirement, when it falls to zero. B A B A I 1 C 1 Y 1 Y 2 C 2 Y 2 + Δ Y 2 Second-period consumption C 2 Y 2 + Δ Y 2 Y 2 C 1 Y 1 I 2 New budget constraint First-period consumption I 2 I 1 New budget constraint Figure 17–9A Figure 17–9B
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Desired consumption is level over the lifetime. Until year T 1 , consumption is greater than income, so the consumer borrows. After T 1 , consumption is less than income, so the consumer saves. This means that until T 1 , wealth is negative and falling. After T 1 , wealth begins to increase; after T 2 , all borrowing is repaid, so wealth becomes positive. Wealth accumulation continues until retirement, when the consumer dissaves all wealth to finance consumption. b. Figure 17–11 shows the case in which a borrowing constraint prevents the consumer from having negative wealth. Before T 1 , the consumer would like to be borrowing, as in part (a), but cannot. Therefore, income is consumed and is neither saved nor borrowed. After T 1 , the consumer begins to save for retirement, and lifetime con- sumption remains constant at C . In Figure 17-11 the consumption path has con- sumption rising up to time T 1 , and then consumption remains constant at C . Chapter 17 Consumption 185 Wealth Income Saving Dissaving Consumption C Levels of income, consumption, and wealth End of life Retirement begins T 1 T 2 Figure 17–10 Wealth Income Saving Consumption C End of life Retirement begins C ' T 1 ' Figure 17–11
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186 Answers to Textbook Questions and Problems Note that C is greater than C, and T 1 is greater than
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HW9_sol - Answers to Textbook Questions and Problems b....

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