Question

Taxes are reduced. Use Keynesian cross model to show graphically the impact of lower taxes on the equilibrium level of income. Label axes, curves, equilibrium, curve shifts.

Explain what happens to income equilibrium due to tax reduction.

Answer 1

In the keynesian cross model the equilibrium is determined where the actual expenditure equals the planned expenditure, and the planned expenditure is the sum of consumption expenditure , investment, government expenditure and net exports. When there is a cut in the tax , so the disposable income would increase and this inturn induces the consumption expenditure. Since the consumption expenditure is a component of the palnned expenditure , the planned expenditure curve will shift upward and the equilibrium income will increase. This is shown below,