Question

In the real world, T is not independent of the level of income. Taxes are typically dependent on the level of income, and so tend to be higher when income is higher. Here, we examine how this automatic response of taxes can help reduce the impact of changes in autonomous spending on output. Consider the following model of the economy: C = C0 + C1YD; YD = Y + TR - T T = t0 + t1Y G and I are both constant. a) (5 pts) Is t1 greater or less than 1? Explain. b) (5 pts) Derive the AD equation as a function of autonomous spending and income. What is the slope of the AD line? Solve for the equilibrium output/income using the equilibrium condition. c) (5 pts) What is the multiplier? Does the economy respond more to changes in autonomous spending when t1 is zero or when t1 is positive? Explain. d) (5 pts) Why is fiscal policy in this case called an automatic stabilizer?

          In the real world, T is not independent of the level of income. Taxes are typically dependent on the level of income, and so tend to be higher when income is higher. Here, we examine how this automatic response of taxes can help reduce the impact of changes in autonomous spending on output. Consider the following model of the economy:
C = C0 + C1YD;
YD = Y + TR - T
T = t0 + t1Y
G and I are both constant.
a) (5 pts) Is t1 greater or less than 1? Explain.
b) (5 pts) Derive the AD equation as a function of autonomous spending and income. What is the slope of the AD line? Solve for the equilibrium output/income using the equilibrium condition.
c) (5 pts) What is the multiplier? Does the economy respond more to changes in autonomous spending when t1 is zero or when t1 is positive? Explain.
d) (5 pts) Why is fiscal policy in this case called an automatic stabilizer?

Added by Danielle J.

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