Answer to Question #113600 in Macroeconomics for John

Question

1. If this analysis is correct, namely that a reduction in wages will reduce the aggregate
demand for goods, what assumption must we make about the relative proportions of wages
and profits that are spent (given that a reduction in real wage rates will lead to a
corresponding increase in rates of profit)? Is this a realistic assumption?
2. If government is running a budget deficit, does this necessarily mean that GDP will
increase? Explain.
3. Assume that the central bank announces a rise in interest rates and backs this up with open market operations. What determines the size of the resulting fall in aggregate demand?
4. If the government decide to cut the basic rate of income tax, which will be the
larger effect – the income effect or the substitution effect – for people (a) on low incomes
just above the tax threshold and (b) on very high incomes? What will be the effect on hours
worked in each case (assuming that the person has a choice)?

Answer 1

1.If it is given that the reduction in wages reduces the aggregate demand for goods,this means that the reduction in income reduces the income of employees which in turn induce them.

2.If government is running a budget deficit the GDP will increase since lower taxes and increased government spending will increase the aggregate demand

3.what determines the size of fall in aggregate demand is the decline in income and wealth

4 a. effect for people on low incomes will have the income effect and in terms of hours worked at low wage levels,higher wages induce people to work more because they make leisure more costly in terms of income that must be given up at the margin to obtain it.

4 b.on very high incomes they will have substitution effect and one will choose to work less hours and take more leisure since lower taxes at the margin increases the financial reward of working