Question

The following equations describe your economy:

Y  = C + I + G

C = ? +cYD

YD = Y + TR – TA

I = ?

G = G(bar)

TA = tY

TR = TR(bar) – rY

(NOTE:  ?, TR(bar)= C-Bar, TR-BAR)

(The bar across the top variables indicates its autonomous)

(Also, ‘t’ is a proportional tax on income, and governs the inverse relationship between transfers and income)

a) Derive an expression for equilibrium output.

b) Discuss the concept of automatic stabilizers. Can transfers in this model be considered an automatic stabilizer? Explain!

c) Now suppose that the government adopts a proposal to impose a tax on transfer payments to its citizens such that TA = t (Y + TR) Using this expression for taxes and the same expression for transfers as given in the model, derive an expression for equilibrium output.

d) Does a tax on transfer payments increase, decrease or leave unchanged the extent of automatic stabilization? Explain!

Answer 1

A.

B.Automatic stabilizers  are features of the structure of modern government budgets, particularly income taxes and welfare spending, that act to dampen fluctuations in real GDP.

This model can be considered as automatic stabilizers because the taxes and transfer payments can be adjusted to bring the economy into equilibrium with government's discretion.

C.please clarify in the comments if it TR or TR(Bar).

I will edit the answer.