Consider a small country that is closed to trade, so its net exports are equal t
ID: 1188474 • Letter: C
Question
Consider a small country that is closed to trade, so its net exports are equal to zero. Suppose the following equations describe the economy of this country in billions of dollars, where C is consumption, DI is disposable income, I is investment, and G is government purchases: C = 30 + 0.5DI G = 40 I = 70 Initially, this economy had a lump sum tax. Suppose net taxes were $30 billion, so that disposable income was equal to Y - 30, where Y is real GDP. In this case, this economy's aggregate output demanded was Suppose the government decides to increase spending by $10 billion without raising taxes. Because the spending multiplier is , this will increase the economy's aggregate output demanded by Now suppose that the government switches to a proportional tax on income of 12%. Because consumers retain the remaining 88% of their income, disposable income is now equal to 0.88Y. In this case, the economy's aggregate output demanded is Under a proportional tax on income of 12%, the spending multiplier is approximately . Therefore, if the government decided to increase spending by $10 billion without raising tax rates, this would increase the economy's aggregate output demanded by approximately A $10 billion increase in government purchases will have a larger effect on output under a .Explanation / Answer
Y = C + G+ I
Y = 30 + 0.5(Y-30) +40 +70
0.5Y = 15+ 40 +70
Y = 125/0.5 = 250
spending mulitiplier = 1/mps = 1/(1-mpc)
= 1/0.5 = 2
increase in aggregate output = 10*2 = 20
Y = 30 + 0.5(.88Y) + 40+ 70
.56 Y = 140
Y = 250
spending multiplier = 1/.56
increase in aggregate output = 17.86
lump sum tax system