--%>
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 : Aggregate demand if government budget

    What occurs to aggregate demand if the government budget is in deficit? Answer: The deficit budget raises the aggregate demand since the deficit budget signifies th

    		•
  • Q : Inflation Effect The economic effects

    The economic effects of inflation are all pervasive. It affects all those who depend on the market for their livelihood. The effects of inflation may be favorable or unfavorable, and low or high depending on the rate of inflation. For example a galloping the hyper inf

    		•
  • Q : Fiscal and Monetary policies How can

    How can governments seek to control their national economies through fiscal and monetary policies?

    		•
  • Q : Federal fiscal stimulus in 2009

    Question: Was the stimulus package passed in 2009 as success?  In answering this question the focus should be the articles on the syllabus, but you should also include opinions of other commentators. &nbs

    		•
  • Q : Value of exports of goods A country’s

    A country’s balance of trade is Rs. 75 crores. The value of imports of goods is Rs. 100 crores. What is the value of exports of goods?

    		•
  • Q : Microeconomics is studying economic

    is studying economic worth your time and effort

    		•
  • Q : Fiscal measures to accurate

    Describe the fiscal measures to accurate the condition of deficient demand and excess demand. Answer: Fiscal measures are the government’s budgetary policy th

    		•
  • Q : What is multiplier Multiplier : The

    Multiplier: The Multiplier is the ratio of change in income by the change in investment. Multiplier (k) = ΔY/ΔI

    		•
  • Q : Base of categorizing receipts into

    What is the base of categorizing receipts into revenue and capital receipts?

    		•
  • Q : Collecting cost-Revenue data from

    Collect cost, revenue data or other relevant data from the airbus industry and describe how you would modify the data to make it relevant to decisions a manager should make.

    		•