An increase in taxes shifts the IS curve. drawn with income along the horizontal

Question

An increase in taxes shifts the IS curve. drawn with income along the horizontal axis and the interest rate along the vertical axis: A) downward and to the left. B upward and to the right. C) upward and to the left. ) downward and to the right. Section 2: (10 points) Q . According to the Keynesian cross. if we have C=300+0.75(Y-T),I=160 and G-T-160. (a) What is the equilibrium level of income? b) If the government would like to increase the current income level by 800, how much C should increase? Thus, how much is the total G? (c) If T increases by 50, will Y increase or decrease? By how much? (hint: use tax multiplier) (d) What is the government purchase multiplier in this question? What is the tax multiplier? re) If both G and T increase by 300, how much will income increase?

Explanation / Answer

a. C = 300 + 0.75 (Y-T)

At eq., savings = investment, Y-C = I

Y - 300 - 0.75(Y-160) = 160

0.25 Y = 160 +300 - 0.75 * 160

Y = 1360

Y = C + I + G - T

(if Y increases by 1 unit, C increases by 0.75 unit hence marginal propensity of consumption (MPC) = 0.75))

b. G multiplier = 1 / (1-MPC) = 1 / (1-0.75) = 4. So, G must increase by 200. total G = 200 + 160 = 360

c. Y will decreases by 50.

d. Govt. purchase multiplier = 4. Tax multiplier = - 1

e. increases by 300*4 - 300 = 900

Cheers

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