Q2. A Model with a Production Tax. Consider the production economy with log preferences, $u(c_1, c_2) = \ln c_1 + \beta \ln c_2$, $y_1 = y$, $y_2 = 0$, and technology $f(k) = k^\alpha$, for $0 < \alpha < 1$. Government spending takes place only in the first period and is financed by a proportional tax on the gross return to investment, $f(k)$. Thus, after-tax profits on investment are:
$PR = (1 - \tau)p_2f(k) - p_1k$
(a) Define a competitive equilibrium for this economy. [10 points]
(b) Compute the equilibrium for a fixed level of $g$. [10 points]
(c) What levels of $\tau$ and $g$ give the private agent the highest utility? Explain. [5 points]
(d) How do your answer to (c) change if utility depends on government spending in the following way: $u(c_1, c_2, g) = \ln c_1 + \beta \ln c_2 + \gamma \ln g$? [5 points]