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# ps5 - show the effects of an increase in tax rates on...

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Problem Set #5 (Fall 2006) 1 Name: _______________________ SID: _______________________ Discussion Section: _______________________ Problem Set #5 Due Tuesday, October 31, 2006 Problem Sets MUST be word-processed except for graphs and equations. QUESTIONS 1. According to the “q” theory of investment, a fall in interest rates raises equity prices, which causes business firms to issue more stock and hence to raise investment. Use an IS-LM model diagram with an Okun’s Law diagram to clearly show the effects of a monetary expansion on equilibrium income, interest rates, and the unemployment rate. Be sure to provide a brief economic explanation of the adjustment process as the economy moves from its initial equilibrium position to its final equilibrium position. 2. The ‘expansionary fiscal contraction” theory claims that when the government reduces the budget deficit, consumer confidence improves. Use an IS-LM model diagram with a Budget Balance diagram to clearly
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Unformatted text preview: show the effects of an increase in tax rates on equilibrium income, interest rates, the actual budget balance, and the structural budget balance. Be sure to provide a brief economic explanation of the adjustment process as the economy moves from its initial equilibrium position to its final equilibrium position. 3. Suppose that a decline in tax rates always raises potential output. Now assume that the economy is at its potential output level and tax rates are reduced. Use an IS-LM diagram with an Okun’s Law diagram and a Budget Balance diagram to clearly show the effects of reduced tax rates on equilibrium income, interest rates, the actual unemployment rate, the natural rate of unemployment, the actual budget balance, and the structural budget balance. Be sure to provide a brief economic explanation of the adjustment process as the economy moves from its initial equilibrium position to its final equilibrium position....
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