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Unformatted text preview: EC 202(01) - Assignment # 4 - S10 - Answers 1 Question One a) Suppose that the government reduces lump-sum taxes. What will happen to the IS curve? Explain using diagrams. Answer: o recall the discussion of the goods market o there is an inverse relationship between C d and lump sum taxes. o this occurs because a tax cut, for example will cause C d to increase o in contrast, there is a direct relation between S d and lump sum taxes since a tax cut will cause S d to fall. IS Curve Factors that Shift the IS Curve The IS curve shifts for two reasons: 1. Shifts in the S d curve that are caused by some reason other than a change in Y these factors include changes in Y f , wealth, G or lump sum taxes 2. Shifts in the I d curve r r 1 / r 1 A / A I d S d , I d S 2 d (Y 1 ) S 1 d (Y 1 ) r r 1 / r 1 Y 1 Y IS 2 A / S-I Diagram IS Diagram IS 1 A Decrease in Lump Sum Taxes See Diagrams o focus on the income level Y 1 , and suppose to start with the goods market is in equilibrium, when r = r 1 o this is shown by point A in both diagrams o now suppose that lump sum taxes decrease o from our earlier analysis we know that national saving will fall, other things equal, including Y...
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- Spring '10