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325_PracticePS2 - Department of Economics University of...

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Department of Economics University of Maryland Economics 325 Intermediate Macroeconomic Analysis Practice Problem Set 2 Professor Sanjay Chugh Spring 2011 1. Interaction of Consumption Tax and Wage Tax. One basic idea of President Bush’s economic advisers throughout his administration had been to move the U.S. further away from a system of investment taxes (which we will discuss later in the course) and more towards a system of consumption taxes . Discussion of a federal consumption tax, which would essentially be a national sales tax, has again emerged in recent policy discussions. Here, you will modify the basic consumption-leisure framework to include both a proportional wage tax (which we will now denote by n t , where, as before, 0 1 n t d ± ) as well as a proportional consumption tax (which we will denote by c t , where 0 1 c t d ± ). A proportional consumption tax means that for every dollar on the price tags of items the consumer buys, the consumer must pay (1 ) c t ² dollars. Throughout the following, suppose that economic policy has no effect on wages or prices (that is, the nominal wage W and the price of consumption P are constant throughout). a. Construct the budget constraint in this modified version of the consumption-leisure model.
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