Multiplier with Endogenous Taxes

Multiplier with - Calculating the Multiplier with Endogenous Taxes Graphically $ E nd og eno us Taxes $ N o Taxes AD AD S lo p e = c S lo p e = c(1

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Unformatted text preview: Calculating the Multiplier with Endogenous Taxes Graphically $ E nd og eno us Taxes $ N o Taxes AD' AD S lo p e = c S lo p e = c (1 - t ) AD' 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.

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