This question is related to A Two-period Model: The Consumption-Savings Decision and Credit Markets
Consider an economy in which consumers have identical preference and income.The income is determined randomly and exogenously in each period. Consumersprefer smooth consumption over time. Production does not involve capital so thatthere is no investment. The government balances its budget each period by collecting a lump-sum tax to nance an exogenous amount of government purchases.
Suppose this is a close economy. Will consumption be less volatile than income in the competitive equilibrium? Explain. (Suppose this is a small open economy facing exogenously given price and interest rate in the international market.) Willconsumption be less volatile than income in the competitive equilibrium? Explain.
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