Question

Q2: Assume that factors that affect the aggregate expenditures of thesample economy, which are desired consumption, taxes, governmentspending, investment and net exports are given as follows:

•Cd=600+0.6 YD,

•T=100 +0.2Y,

•G=400,

•Id=300,

•NXd=200 – 0.1Y,

•TR=0

a) According to the above information explain how the tax collection changes as income in the economy changes?

b) Write the expression for YD.

Answer 1

a) It is given that -

Tax, T = 100+0.2Y

Thus the tax structure suggests, everyone in the economy has to first pay a lump sum tax amount of 100 irrespective of their income level and further they have to pay 20% (i.e. 0.2) of their income as tax.

Hence if we consider the relation between Income and Tax charged in the economy it can be stated that -

With increase in income of the economy the tax revenue increase proportionately (as 20% of income has to be paid as tax). From equation of tax charged, it can be seen that if income of the economy rises by 1 unit, it will raise the tax revenue by 0.2 unit.

b) YD is the expression for disposable income i.e. income left after paying taxes. In other words YD can be expressed as the part of income that the consumer can spend wherever he/she wants (i.e he can consume it, invest it or save it).

Thus the expression for YD can be written as -

YD = Y - T

Or, YD = Y - (100+0.2Y)

Or, YD = Y - 100 - 0.2Y

Or, YD = (1-0.2)Y - 100

Or, YD = -100 + 0.8Y

The above is the expression for disposable income.