Answer to Question #298292 in Macroeconomics for mubarik

Question

Consider the following general version of the Keynesian cross:

Y = C + I + G

C = a + b(Y − T)

I = c − dr

Assume that taxes (T) are not fixed but depend on income in the following

way:

T = T ¯ + tY

where T > ¯ 0 and 0 < t < 1 are parameters of the tax system.The parameter t is the marginal tax rate: if income rises by $1, taxes rise by t$1.

Furthermore, a > 0,0 < b < 1, c > 0, d > 0.

(a) How does this tax system change the way consumption responds to

changes in GDP?

(b) In the Keynesian cross, how does this tax system alter the governmentpurchases multiplier?

(c) Find the IS equation from this Kenesian cross mode. How does this

tax system alter the slope of the IS curve?

Answer 1

A) An increase in the GDP will translate to an increase in the taxes since the tax is a function of income. Therefore though consumption will increase with increase in GDP, the increase will not be equivalent to the the increase in the GDP.

B) An increase in the taxes increases the the government purchases. Taxes will increase with expansion of the GDP.

C) The IS curve depicts all the instances when the Investment is equal to the Savings. Therefore the investment function: $I=c-dr$

Represents IS curve.