Consider the following simple model with investment and government

spending exogenous:

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?

Why?

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.

spending exogenous:

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?

Why?

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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