A two-period endowment economy as we studied in class has consumers with identic

Question

A two-period endowment economy as we studied in class has consumers with identical preferences and the consumption good is non storable. Suppose that there is a benevolent government (i.e. a government that seeks to maximize the welfare of consumers) that imposes lump-sum taxes and make lump-sum transfers. (Recall, taxes can be negative, in which case they are called transfers.) The government must satisfy its present-value budget constraint T2 1+r where T, denotes taxes (T, >o) or transfers (T 0 and T2

Explanation / Answer

In economics consumption is one of the major components of expenditure. It depends upon the disposable income of the individual. According to Fisher the consumption of present and future depends on both present and future income. That is at equilibrium the present value of total consumption must equal the present value of total income.

Thus in this case as the present value of total tax and transfer is zero, the total present value of income is unchanged post tax. This also implies that the consumer chooses the same level of consumption after tax. The tax only alters the savings of the consumer.

On the otherhand, as the present and future income remain unaltered, the utility or welfare of the conusmer that solely depends on the level of consumption remains unchanged after tax. hence, it is not possible to incre the welfare of the consumer as long as the present value of tax and transfer is zero.

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