Instructor: Marco Del Negro
Economia V, Spring 2000

PROBLEM SET 3, SOLUTIONS

a) The government budget constraint is:

$$T_{1}+\frac{T_{1}}{1+r^w}= G_{1}+\frac{G_{2}}{1+r^w}$$

So taxes tomorrow will be:

T₂=.5+.5=1

b) The household's budget constraint is:

(1+r^w)(Y₁-C₁)=C₂-Y₂

or:

C₁=2-C₂

c) The first order conditions (see class 5) are:

$$\frac{1}{C_{1}}-\frac{\beta(1+r^w)}{C_{2}}=0$$

when $\beta=\frac{1}{1+r^w}=1$ the first order conditions implies C₁=C₂. Substitute this condition into the budget constraint and obtain

C₁=C₂=1

d) By definition, since I=0 (no investment in this endowment economy)

CA = S = Y₁-C₁-G₁=-1-.5=-1.5