Graphical treatment of taxes and fiscal policy The main difference between varia

Question

Graphical treatment of taxes and fiscal policy

The main difference between variable taxes and fixed taxes is that unlike fixed taxes, variable taxes (do not vary with GDP/ rise and fall with GDP).

The following graph shows the consumption schedule for an economy with a given level of taxes. Suppose the government implements a tax increase through a fixed tax.

Use two green points (triangle symbol) to connect the two black points (plus symbols) representing the consumption schedule after the change in taxes. (Hint: The new consumption schedule must pass through one point on the left and one point on the right.)

Use the green points (triangle symbols) to draw the new total expenditure line on this graph given the tax increase through a fixed tax previously discussed and subsequent changes in the consumption schedule shown on the preceding graph.

50 Consumption with tax increase through a fixed tax 40 Consumption with tax increase through a variable tax 20 O 10 20 40 100 REAL GDP (Billions of dollars) The blue line on the next graph represents the original total expenditure line for this economy before the change in tax structure Use the new consumption line you just plotted to calculate the new total expenditure at two levels of real GDP and fill in the following table GDP level Total Expenditure (Billions of dollars) 10 90

Explanation / Answer

The change in equilibrium output is smaller when the government implements the variable tax hike.

Ans True

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