Disposable income Yd is given by Y T, where T is total taxes. Suppose
that taxes are not directly related to income, so that T can be increased or
decreased independent of income.
a. Derive the change in Y associated with an increase in taxes T. Show
the results graphically and algebraically. What is the tax multiplier?
That is, what is Y/T?
b. Compare the tax multiplier with the government spending multiplier
derived in the text. Aside from the difference in signs, which is larger?
c. Now increase government spending G and taxes T by the same
amount. For this change, the government budget deficit G T does
not change. If the budget was balanced before, it will still be balanced.
What happens to income Y in this case? Perhaps surprisingly, it increases.
Calculate by how much. That is, using algebra, calculate
Y/G; G T. The result is called the balanced budget multiplier.
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