Economics 2152A/B Study Guide - Classical Economics, Ricardian Equivalence, Budget Constraint

Consider the One-Period Model.

Suppose that the production function that the rm operates is now given by
Y = z(G)F(K;N^d); with z(G) = (z + aG);
where z > 0, a > 0, and G > 0 is government spending.

Notice that in this framework government spending makes firms more productive (for
For example, government expenditures on roads and bridges lower the cost of transportation).
The budget constraint for the government is G = T, where T is lump-sum taxes.

1. Suppose that the government decides to increase G. Using a diagram, determine the
equilibrium effects of this shock on aggregate output, consumption, employment, and
the real wage. Show that increasing G can potentially increase welfare.

2. Compare your results with the case of unproductive government spending studied in
class (i.e., when a = 0).

consider the following two-period model. The consumer has preferences given by: u(c,c')=ln c + ß ln c' where c is current consumption, c' is future consumption, and ß >0 is a discount factor. The consumer receives exogenous income y u tge current period and y' in the future period. The consumer pays proportional tax ts on savyings (i.e. the consumer saves s in the current period but only gets (1-ts) tomorrow). The consumer can save at the interest rate r.

a) Write down the consumer's budget constraint for the current period.

b) Write down the consumer's budget constraint for the future period.

c) Combine the two budget constraints above into one lifetime budget constraint

d) Solve the consumer's optimization problem for c and c'

e) Write down the tax revenue the government receives then imposing the tax on savings.

Consider the One-Period Model.

Suppose that the production function that the rm operates is now given by
Y = z(G)F(K;N^d); with z(G) = ( z bar + aG);
where z > 0, a > 0, and G > 0 is government spending.

Notice that in this framework government spending makes firms more productive (for
example, government expenditures on roads and bridges lowers the cost of transportation).
The budget constraint for the government is G = T, where T are lump-sum taxes.

1. Suppose that the government decides to increase G. Using a diagram, determine the
equilibrium e ects of this shock on aggregate output, consumption, employment, and
the real wage. Show that increasing G can potentially increase welfare.

2. Compare your results with the case of unproductive government spending studied in
class (i.e., when a = 0).

please show the diagram (Consumption on y aixs and leisure on x axis) for question 1

what I found was increase in G and Z happen at the same time!

Thanks!