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Econ420S10_HW3_Solution - Economics 420 Spring 2010...

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Economics 420 - Spring 2010 Mike Aguilar Intermediate Theory: Money, Income & Employment UNC at Chapel Hill HW # 3 Due - 02/08/2010 Instructions : Please explain your answers thoroughly and show all necessary work. State your assumptions carefully. There may be more than one correct solution. Please type your answers whenever possible. Students may work together, but each must submit their own work. The honor code is in effect. Note: Maintain a ceteris paribus assumption when interpreting all shocks. 1. (5pts) Consider a Classical economy, where the lump sum taxes are reduced. Your classmate suggested the following interpretation of the impact this shock will have on the economy: The tax reduction will not affect the total saving, since S = PrS + PuS = ( Y - T - C )+( T - G ), where the tax T will be cancelled out. The tax reduction will increase disposable income Y D , which will increase consumption C . This will shift AD curve rightwards and have no influence on the loanable funds market. Analyze these two responses. Support those aspects with which you agree, debate those aspects with which you disagree, and include any aspects that she may have omitted.Provide any necessary
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