Question

Suppose a nationwide small-government movement leads state and local governments to

significantly reduce their capital spending on roads and other infrastructure. Using the lenders' -

borrowers' curve apparatus discussed in class or other appropriate tools, analyze the effect this

change in behavior would have on:

1) the yield of tax exempt bonds (r E),

2) the quantity of tax exempt bonds issued (Q E), and

3) the implied marginal tax bracket T M

Answer 1

1.) Yield of tax exempt bonds:- As you know when govt. reduce to do expenditure on roads & other infrastructure then the flow of money in market will reduce and the borrowings power of consumer will also reduce therefore any bonds which have been taken by consumer they will sell it off to get money from it or converted such bond into money, and when all bonds converted into money then the yield of bond will increase.

2.) Quantity of tax bond issued:- When govt. reduce to do expenditure then govt,. also need no money for expenses because when govt. plan to expense in future it will issue bonds to public for requirement of money hence when there is no need of expenditure so there is no need of issue bonds.

3.) The implied marginal tax bracket:- The tax bracket will be lower because when there is no expenditure then public doesn't earn money and there earning will be less and if earning will be less then the tax bracket is required to be low.