NONCONNECTEDNESS OF THE SET OF BANKRUPTCY-FREE MONEY EQUILIBRIA IN THE STATIC ECONOMY: A CONSTRUCTIVE EXAMPLE

Abstract

A static economy in which nominal taxes and transfers are balanced, as proposed by Balasko and Shell (1993), typically has a continuum of equilibrium money prices. This paper presents a constructive example in which the set of equilibrium money prices is not connected. By allowing negative consumption as a mathematical construct, closed form solutions for equilibrium tax-adjusted income are derived. The main result of the example implies that bankrupt taxpayers with negative tax-adjusted income can be free from bankruptcy as the price of money increases. This paradoxical outcome is similar to that of the transfer paradox, as suggested by Gale (1974), where tax-transfer plans make taxpayers better off.