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Unformatted text preview: Calculating the Multiplier with Endogenous Taxes Graphically
$ E nd og eno us Taxes $ N o Taxes
S lo p e = c S lo p e = c (1 - t )
AD ∆A Y Y'
∆Y ∆A Y Y'
∆Y The multiplier is equal to the change in Y divided by the change in autonomous
spending. The slope of the spending line without taxes is equal to just the MPC
which is little c. In the simple model, the only type of spending that depends on
the level of Y is consumption spending.
In the model with endogenous taxes, the only type of spending that depends on
the level of Y is again just consumption spending. However, in this case
consumption spending takes place out of disposable income so the fraction of
each dollar actually spent is c (1 – t). If the tax rate is 10% and the MPC is .9
then only 81 cents of each dollar earned is spent. Taxes have reduced the size
of the multiplier from 10 to about 5!
As shown above, the spending line is flatter if taxes are included. Looking at the
two graphs we can see that although the vertical shift of the AD curve is the
same for both graphs, the change in Y is much greater in the case of no taxes
compared to the case of endogenous taxes. The conclusion is that including
income taxes in the economy has decreased the amount by which the level of Y
will change when an autonomous shock hits the economy. Taxes have reduced
the amount of fluctuation in Y and therefore they are an “automatic stabilizer”. ...
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This note was uploaded on 04/04/2012 for the course ECON 200H taught by Professor Staff during the Winter '11 term at Ohio State.
- Winter '11