Answer to Question #193200 in Macroeconomics for Row

Question

Q) Assume consumers with standard preferences live for two periods. They receive an income in each period (𝑦 and 𝑦′) and pay lump-sum taxes to the government (𝑡 and 𝑡′). Credit markets are not perfect, and borrowers are charged a higher interest rate than lenders. The government never defaults, and faces the lenders’ interest rate whether it borrows or lends. Which are true?

a) The number of lenders is equal to the number of borrowers

b) A reduction in taxes in the current period without changes in the lifetime burden of taxes increases

current consumption for a lender

c) A borrower is better off if there is a reduction in the interest rate paid by borrowers

d) A borrower is better off if there is a reduction in the interest rate paid by borrowers, but only if the

substitution effect dominates the income effect

e) A reduction in taxes in the current period without changes in the lifetime burden of taxes may

transform a borrower into a lender

Answer 1

Given:

Receive an income in each period (y and y′) 

pay lump-sum taxes to the government (t and t′)

Credit markets are not perfect.

Borrowers are charged a higher interest rate than lenders.

The government never defaults and faces the lenders’ interest rate whether it borrows or lends.

Therefore, from the above information, we will explain the substitution effect, the effect which is the decrease in sales for a product that can be considered as attributed to customers switching to cheaper alternatives when the price increase. Suppose a brand's price increase, then the result will be that some consumers will go for a cheaper alternative.

An answer is an option(d) i.e A borrower is better off if there is a reduction in the interest rate paid by borrowers, but only if the substitution effect dominates the income effect. Therefore, this statement is true from all the following which is clear from the above discussion