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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 Winter '08
 Serra
 Macroeconomics, TA, tax cut

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