Question

3. Show what happens to the Aggregate Expenditures line if the country runs a trade surplus, i.e. draw in a new curve labeled C+I+G+Xn or describe where that new curve goes. (10 points)

4. Mr. A makes $50,000 a year and pays $10,000 in taxes. Ms. B makes $30,000 a year and pays $6,000 in taxes. Find the tax rate and after tax income for each of them. Identify what type of tax this is – progressive, flat or regressive. (25 points)

5. Consumption is $6 trillion, investment is $2 trillion and government purchases are $2.5 trillion. The country exports $1 trillion and imports $1.5 trillion. Find net exports and solve for the level of aggregate demand. (10 points)

Answer 1

3. Aggregate Expenditures line has a composition of AE = C + I + G + NX. Now an important factor that shifts the AE line is net exports. A fall in the amount of imports or an increase in the amount of exports would increase net exports and would therefore result in trade surplus. If the country runs a trade surplus the AE line shifts outwards to the right. The new AE curve would lie next to the old AE curve.

4. Mr. A makes $50,000 a year and pays $10,000 in taxes. Hence his tax rate (average) is 10000/50000 = 100/5 = 20%. Ms. B makes $30,000 a year and pays $6,000 in taxes. Hence his tax rate (average) is 6000/30000 = 100/5 = 20%. This tax rate is flat because it charges 20% of the income of the taxpayer irrespective of the income. The after tax income of Mr. A is 50000 - 10000 = $40,000 annually while after tax income of Mr. A is 30000 - 6000 = $24,000 annually

5. From the equation of AD line, we see that C + I + G + (X - M) = $6 trillion + $2 trillion + $2.5 trillion + ($1 trillion - $1.5 trillion)

Here, net exports are X - M or ($1 trillion - $1.5 trillion) = -$0.5 trillion

The level of aggregate demand is therefore AD = $6 trillion + $2 trillion + $2.5 trillion - $0.5 trillion = $10 trillion