Assume a closed economy (no import or export) characterised by the following equations describing the behaviour of aggregate demand: Consumption function: C = Co + C₁(YT) T = to +t₁Y [Taxation rule] Investment and government spending are assumed to be constant: I = I and G = G Where co is autonomous consumption, to is autonomous taxation, C₁ = 0.6 is the marginal propensity to consume, t₁ = 0.2 is the sensitivity of tax revenues to income. a) Explain why it is reasonable to assume that government tax revenues would respond to changes in income. b) Solve for the equilibrium output in the goods market. c) What is the Keynesian multiplier in this economy? How is it related to the parameters of the model. d) Assume autonomous consumption co falls by £1 Billion. Calculate the change in equilibrium output. Represent the effect of the shock on a Keynesian cross diagram. Complete the table below and explain in words how the taxation rule affects the Keynesian multiplier. e) f)

Assume a closed economy (no import or export) characterised by the following equations describing the behaviour of aggregate demand: Consumption function: C = Co + C₁(YT) T = to +t₁Y [Taxation rule] Investment and government spending are assumed to be constant: I = I and G = G Where co is autonomous consumption, to is autonomous taxation, C₁ = 0.6 is the marginal propensity to consume, t₁ = 0.2 is the sensitivity of tax revenues to income. a) Explain why it is reasonable to assume that government tax revenues would respond to changes in income. b) Solve for the equilibrium output in the goods market. c) What is the Keynesian multiplier in this economy? How is it related to the parameters of the model. d) Assume autonomous consumption co falls by £1 Billion. Calculate the change in equilibrium output. Represent the effect of the shock on a Keynesian cross diagram. Complete the table below and explain in words how the taxation rule affects the Keynesian multiplier. e) f)

ENGR.ECONOMIC ANALYSIS

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ISBN:9780190931919

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Chapter1: Making Economics Decisions

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Question

Section 2 - Exercises
Exercise 1: Automatic stabilisers
Assume a closed economy (no import or export) characterised by the following equations
describing the behaviour of aggregate demand:
Consumption function:
C = Co + C₁ (YT)
T = to +t₁Y [Taxation rule]
Investment and government spending are assumed to be constant: I = I and G = G
Where co is autonomous consumption, tå is autonomous taxation, c₁ = 0.6 is the
marginal propensity to consume, t₁ = 0.2 is the sensitivity of tax revenues to income.
a)
Explain why it is reasonable to assume that government tax revenues would
respond to changes in income.
b)
Solve for the equilibrium output in the goods market.
c) What is the Keynesian multiplier in this economy? How is it related to the
parameters of the model.
d) Assume autonomous consumption co falls by £1 Billion. Calculate the change in
equilibrium output.
e)
Represent the effect of the shock on a Keynesian cross diagram.
f) Complete the table below and explain in words how the taxation rule affects the
Keynesian multiplier.

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