7. (5 points) Suppose that the government reduces current lump-sum taxes, but does not
change current or future government purchases. Using the real intertemporal model
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we developed in class, show how these changes would affect output, employment, real
wages and the real interest rate. What happens to consumption and investment?
(Hint: Graphs are unnecessary if you can provide a brief but compelling economic
argument.)
8. (15 points) In questions 1(c) of Exam 1, you investigated the effects of imposing a
proportional labour income tax, rather than lump-sum taxes. Suppose that this new
fical regime is permanent, i.e., the government makes purchases and collects labour
income taxes in all periods. Using the real intertemporal model we developed in class,
show graphically how these changes would affect output, employment, real wages, and
the real interest rate. (Hint: You should review question 1(c) of Exam 1 to determine
how the labour market changes, and you should then determine how desired output
demand changes.)