Answer to Question #243562 in Macroeconomics for Tina

Question

Within the classical model, analyze the effects of an increase in the marginal income tax rate. Explain how output, employment, and the price level are affected. Consider cases in which the increased revenue produced by the tax increase results in a decline in bond sales to the public and in which it results in lower money creation.

Answer 1

An increase in the marginal income tax rate will decrease output, decrease employment, and decrease the price level. In some cases the increased revenue produced by the tax increase results in a decline in bond sales to the public or lower money creation.

Imposition of taxes results in the reduction of disposable income of the taxpayers. This will reduce their expenditure on necessaries which are required to be consumed for the sake of improving efficiency. As efficiency suffers ability to work declines and this ultimately adversely affects savings and investment.

When taxes increase consumption goes down, leading to a decrease in output. The decrease in income reduces the demand for money and given that the supply of money is fixed, the interest rate must decrease to push up the demand for money and maintain the equilibrium.