ECON102 Lecture Notes - Lecture 19: Fiscal Policy, Potential Output, Real Wages

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Supply-side effects: fiscal policy has important effects on employment, potential. The vertical distance between the ls curve and the ls + tax curve measures the amount of the income tax. The effects of an income tax on labour income. At point a, the real wage has adjusted to make the quantity of labour demanded = the quantity of labour supplied. Potential gdp = real gdp produced at full-employment. An income tax gives labour less incentive to work. In this example, - = . The effects of a tax on capital income. A tax on capital (interest) income is a disincentive to save. (slf) In this example, the equilibrium interest rate rises to 4% but the after-tax interest rate falls to 1%: however, only nominal amounts are taxed so we must also consider the inflation rate. Numerical example using the after-tax real interest rate. Nominal interest rate = real interest rate + inflation.

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