In the above question, calculate the effect on output of a 10 per cent increase in transfers, and a 10 per cent increase in lump-sum taxes. Compare the effects of the two.

Question

Philoid · Accepted Answer

Given is

C = 20 + 0.80 Y (C = 20 & MPC = 0.8)

I = 30

c = 0.80

G = 50

TR = 100

∆TR = 10

(a) Equilibrium level of income = 1/(1-c) [C + cTR + I + G + c∆TR]

= 1/ (1 – 0.8) [20 + (0.8 X 100) + 30 + 50 + (0.8 x 10)]

= 940

∆Y = 940 – 900 = 40

Change in income due to change in tax

∆Y = -c/1-c X ∆T = - 40

Therefore increase in 10% in transfer will raise the income by 40% and increase in 10 % in tax will decrease the income by 40%