Overview

Introduction

We now augment the Ramsey model, incorporating a government.

It taxes households with a lump-sum tax $T_{t}$ and uses these proceedings to buy goods $G_{t}.$ Assumption RG 1 We assume that government purchases do not affect the utility derived from private consumption. This can be because:

• The government devotes revenue $T_{t}$ to an activity households do not derive utility from
• Households utility equals the sum of private consumption and goods provided by the government.

Assumption RG 2 Another assumption is that the government uses all taxes to fund exclusively its purchases $G_{t}.$ Therefore, the government does not save: no public investment.

Finally, the government runs a balanced budget in each and every period: $G_{t} = T_{t}.$i¹

This extension does not modify the behaviour of firms. In fact, taxes affect only households through their budget constraint.