MT2_AK_C-1

# MT2_AK_C-1 - Part C 1 1.1 Tax cut shifts the IS to the...

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Part C 1 Tax cut shifts the IS to the right 1.1 By equations. .. Expenditure curve is E = c ( Y T ) + I + G . IS curve is given by: Y = E , Y = 1 1 c ( I + G ) c 1 c T . Hence, tax cut T < 0 implies increase in income Y > 0 , keeping other things constant. This means the rightward shift in the IS. 1.2 In words. .. Tax cut increases disposable income. Keeping interest rate constant, this will shift up the expenditure curve (increase the intercept). Hence, the intersection of Keynesian cross moves to the right. That means we have higher income that clears goods market for given interest rate. This is the rightward shift in the IS curve. Ask your TA for graphical explanations. (7pts for any of three methods or combinations, as long as consistently explained.) 2 "T" v.s. "G" for the horizontal shift in IS 2.1 By equations. .. Write the IS curve in terms of changes: Y = 1 1 c ( I r G ) c 1 c T . Set r = 0 to see the size of horizontal shift Y . By only the tax cut (set G = 0 ), Y tax = c 1 c T . By only the government spending (set T = 0 ), Y g = 1 1 c G . Hence, if we compare two policies of the same size ( j T j = j G j ), Y g > Y tax , since 1 1 c > c 1

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MT2_AK_C-1 - Part C 1 1.1 Tax cut shifts the IS to the...

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