Two friends, Lucy and Adam, start working at the same time, right after graduating from university. Lucy works as a computer programmer for an annual salary of $70,000; Adam as a teacher for an annual salary of $45,000. Both friends expect their annual salary to increase by 2% in real terms each year for the next 3 years. The real interest rate is 0% and the tax rate on labor income is 30% for both friends. Lucy has no nonhuman wealth, while Adam was just bequeathed $50,000 worth of bonds from an old aunt who passed away.
a. Calculate the human wealth and the total wealth of the two friends over the next three years (assume there is uncertain-ty about the future beyond during these three years).
b. If both friends wanted to maintain a constant consumption level over this period, what would that consumption level be?
c. How would an increase in taxation (to, for instance, 40%) affect the relative wealth positions of Lucy and Adam? How would that affect their permanent consumption levels?
d. Suppose that Lucy works for a firm whose stock market value jumps after being bought by a multinational, and that as a result, Lucy, along with all her colleagues, sees her salary increase by 10% instead of 2% in real terms in the next 3 years. How does that change Lucy’s human wealth?
e. If the increase in salary were to be made permanent, how would that affect Lucy’s consumption levels?
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