# Term in the utility function may have changed over

• Homework Help
• 17
• 100% (1) 1 out of 1 people found this document helpful

This preview shows page 13 - 15 out of 17 pages.

term in the utility function may have changed over the years. Your explanation should be stated in both mathematical terms AND in economic terms (that is, the economic explanation should not simply be a verbal restatement of the mathematics).Solution: The main economic idea conveyed by the d term is that individuals receive direct happiness (“utility”) from their stock of wtit(again, think in terms of heating, cooking, etc). Using the oil pricing expression in part c and in ceteris paribus terms, oil prices rose because individuals “enjoyed” using oil more. This would be interpreted as d during the last decade was larger than d during the earlier years. We could offer a huge number of underlying explanations for this (a couple of prominent examples are lack of efficiency of energy use by individuals and growing demand for heating in developing economies). No matter what precise underlying explanation might carry the most weight, from the view of the framework in this question, it is increased demand for oil usage that caused the increase in oil prices. Technically, it is an increase in d that led to an increase in Swti. Finally, a note of caution in the economic interpretation here: this consumer-oriented problem only articulates a demand-side notion of oil prices. It does not speak much, if at all, to the supply side of oil markets.
Macroeconomic Theory and Policy – Midterm Exam | © Sanjay K. Chugh 14 Problem 4: An Alternative Interpretation of Ricardian Equivalence? (30 points) Consider a modified version of the two-period framework with government studied in Chapter 7. By “government” here we will mean just the “fiscal authority;” suppose there is no “monetary authority” at all. The government and the representative consumer each live for both periods of the economy, and suppose there are never any credit constraints on the consumer. The government does not have access to lump-sum taxes, only proportional consumption taxes. However (this is different from our baseline framework), the consumption taxes the government collects in a given period are not restricted to be levied on consumption from only in that period. To be more precise, suppose that total consumption tax revenues the government collects in period 1 are based only on period-1 consumption (because there was no period zero, say). However, total consumption tax revenues the government collectsin period 2 are based on both period-1 consumption andperiod-2 consumption. That is, a portion of the revenue collected in period 2 is based on period-1 consumption, and the remaining portion of the revenue collected in period 2 is based on period-2 consumption. Denote by 1,1τthe tax rate on period-1 consumption that is levied in period 1; denote by 1,2τthe tax rate on period-1 consumption that is levied in period 2; and by 2,2τthe tax rate on period-2 consumption that is levied in period 2. There is no 2,3τ(which would represent the tax rate on period-2 consumption that is levied in period 3) because the economy does not exist in period 3.