--%>
Assignment Help - homework help

Explain Tax rate increase.

A change in tax rate changes the IS equation, LM equation remaining the same. Let same, let us suppose that the government raises the tax rate from 20 percent to 25 percent. The rise in tax rate from t = 0.20 to t = 0.25 would change the IS equation by changing the consumption function with increase in tax rate, the consumption function changes form C = 100 + 100 + 0.60 Y, given in Eq. to 

C= 100 + 0.75 [Y - (40 + 0.25Y + 40)]

= 100 + 0.5625Y

With change in the consumption function, the new IS schedule (say, IS2) can be obtained as follows. 

IS2 schedule: 

Y = C + I + G + ?G

= 100 + 0.5625Y + 250 - 4i +200

= 1257.14 - 9.14i

Given the new IS function (IS2) in Eq. the new equilibrium interest rate can be worked out as follows.

Is2 = LM

1257.14 - 9.14i = 800 + 80i

89.14i = 457.14

I = 5.13 (percent)

Once interest rate is known equilibrium income with tax effect can be computed by substituting the interest rate (5.13%) into the IS2 or LM equation. By using IS2 function, we get

Y = 1257.14 - 9.14i = 1257.14 - 9.14 (5.13)

The negative effect of increase in tax rate on the equilibrium income equals income before tax - rise less income after tax-rise that is

Tax effect = $1311.10 bn - $1210.25 bn

$100.85 billion

This calculation shows that increasing tax rate form t = 0.20 to I = 0.25 decreases equilibrium income by $100.85 billion. 

   Related Questions in Macroeconomics

  • Q : Definition of surplus Definition of

    Definition of surplus: It is a condition in which quantity supplied is more than quantity demanded. To remove the surplus, producers will minimize the price till the market reaches to equilibrium.

    		•
  • Q : Value added technique for national

    What is the alternative name of value added technique of estimating national income? The alternative name of value added technique of estimating national income is production method.

    		•
  • Q : Limitation of credit availability What

    What occurs to economy, when credit availability is limited and credit is made costlier? Answer: Aggregate demands falls

    		•
  • Q : Analyzing regions leading transaction

    Analyze at least 3 possible regions for the industry which could lead to transaction costs, explaining each in detail.

    		•
  • Q : Agency function of Commercial Bank Name

    Name the six agency function of Commercial Bank. Answer: A) Transfer of funds B) Collection of funds C) Purchase and sale of securities. D) Collection of dividends E) Payment of bills &

    		•
  • Q : Weighed marginal cost and marginal

    Cite examples of recent decisions that you made in which you, at least implicitly, weighed marginal cost and marginal benefit?

    		•
  • Q : Demand curves when longer periods are

    Whenever longer periods are considered and hence bigger ranges of adjustments (that is, substitutions) become probable, demand curves tend to become: (i) Flatter, and therefore do supply curves. (ii) Flatter, as supply curves become steeper. (iii) Ste

    		•
  • Q : Type of market when people cannot buy

    Whenever people can’t purchase all of a good they are willing and capable to pay for at present market price, there is surely a market: (1) Price ceiling. (2) Price floor. (3) Shortage. (4) Anomaly.  (5) Surplus. Please

    		•
  • Q : Money-just another good ‘What occurs in

    ‘What occurs in the money market when there is a raise in income?’

    		•
  • Q : Market shift when exporting When the

    When the U.S. furniture market is primarily in equilibrium at point e on S0D0 and then Chinese manufacturers start exporting more furniture to the United States, then this market would shift towards a new equilibrium at: (1) point a. (2) point b. (3) point c. (4) poin

    		•