Exercise 2 75 marks Consider an economy of threeperiodlived

Exercise 2 (7.5 marks): Consider an economy of three-period-lived people in overlapping generations. Each person is endowed with y goods when young and old and nothing when middle-aged. The population of each generation born in period t is Nt , where Nt -nNt-1 There are no assets other than loans. a. Explain how credit can be used to provide for consumption when middle-aged. Point out who lends to whom. b. Write the condition for the equality of supply and demand for loans in periodt. c. Write the budget constraints for the young, the middle-aged, and the old.

Solution

(b) Equilibrium equality demand supply. Prices where demand and supply are out of balance are termed points of disequilibrium. Changes in the conditions of demand or supply will shift the demand or supply curves. This will cause changes in the equilibrium price and quantity in the market.

(c) there are two basic ways to finance government social security payments to the old. in a fully funded pension plan, the government taxes young workers and uses these contributions to purchase interest bearing assests that will finanace the pension payments to that some cohort of workers when they are old. the payments to the old are funded by taxes on those who are young in that period.