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Suppose the government is considering a tax policy that will reduce taxes by $100. In the economy, households consume 80% of each additional dollar earned. Assume that the tax cut doesn't affect GDP (Y). 

a) How will this tax affect consumption?

b) Calculate the change in private savings.

c) Calculate the change in government savings and national savings.

d) What will happen to the current account as a result of this policy?

e) How would your previous answers change if we assume Ricardian equivalence?

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Divya Singh
Divya SinghLv10
28 Sep 2019

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Related questions

Suppose the government is considering a tax policy that will reduce taxes by $100. In the economy, household consume 80% of each additional dollar earned. Assume that the tax cut has no effect on GDP (Y)

(a) How will this tax affect consumption?
(b) Calculate the change in private savings.
(c) Calculate the change in government savings and national savings
(d) What will happen to the current account as a result of this policy?
(e) How would your previous answers change if we assume Ricardian equivalence?

True or False Questions:

1. Recessionary Expenditure Gap- Aggregate expenditures by which aggregate expenditures at the full employment GDP falls short of those required to achieve full employment GDP.

2. Private Closed Economy- An economy that includes consumer, business, and government segments of the economy.

3. Lump-sum taxes- A tax of a constant amount so the government obtains the same amount of tax at each level of GDP.

4. Aggregate Supply schedule- A relationship between a nation's price level and the amount of real domestic output that is produced.

5. Real Rate of Interest effect- The Nominal Rate of Interest earned on a project.

6. Savings- savings are planned investments by the consumer.

7. Wealth effect- The dollar amount of all the assets owned minus the dollar amount of all the liabilities or debt.

8. Savings Schedule - GDP less investment = savings

9. Aggregate Demand Schedule- a schedule that shows the amount of a nation's output (real GDP) that buyers desire to purchase at each price level.

10. Productivity- The measure of the level of the nation of real output and the amount of resources used to produce the output, less labor cost.

11. Multiplier effect- Measures the change in GDP to spending.

12. Injection- Investment by private business into the economy for capital goods is and injection into the economy.

13. Consumption schedule- The measurement of Disposable income less savings.

2. The economy of Littleton is currently producing 1 trillion dollars less than their full employment GDP level of 5 trillion dollars. Assuming the government chooses to utilize fiscal policy and adds 500 billion dollars of new spending, and they have a MPC of .80, perform the following:

a. Identify the induced change for each type of policy.

b. Identify the total change for each type of policy.

c. Illustrate the pre and post fiscal policy situation using the AD/AS model.

d. Assuming Crowding out or Ricardian Equivalence, what will change?

e. Assuming government borrows the money to engage in the new spending, what is likely to happen to:

i. Interest rates (increase or decrease)?

ii. The value of the dollar (appreciate or depreciate)?

iii. How would each of these impact C, I, G, & NX

iv. What would be the effectiveness of the fiscal policy as a result of the borrowing (amplify or diminish)?

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