Economic Policy /tutorial/ 4-1 Inequality and Redistribution

Economic Policy /tutorial/ 4-1 Inequality and Redistribution

Consider an economy inhabited by a continuum of citizens normalized to unity in which aproportional tax on labour τ is used to finance the lump-sum transfer g . Individual i’spreferences over consumption c and leisure x are described by: w = c −a b− x with parameters a > 0and i b ≥1 . The real wage is assumed to equal one and the labour supply is li , so that the privatebudget constraint is ci = (1 – τ)li + g , and the government’s budget constraint is: g =τl . Theindividual is also subject to a time constraint:1 + ei = li + x , where ei captures the individualproductivity and is a random variable distributed according to a special density function.