Question

An economy is described by the following equations:

Y = C + I + G

C = c₀+ c₁.Y_D

Y_D= Y – T

T = t₁.Y – t₀

And 0 < c₁< 1,

0 < t₁< 1,

c₀> 0,

t₀> 0,

G and I are autonomous and higher than zero.

1. Is the following statement true? “An increase in the marginal income tax rate t₁leads to a reduction of the primary deficit of the government (=G – T)”

2. Does the tax for the economy as described above act as an automatic stabilizer?
   
   
3. Assume that the tax an individual pays is according to the following rules:
   • if income is below €10,000 then there is a negative tax of €10,000 – individual’s income
   • if income is above €10,000 and below €50,000 then tax to be paid is 25% of (individual’s income - €10,000)if income is above €50,000, then tax to be paid is €10,000 + 40% of (individual’s income - €50,000).
     
     Does this tax system act as an automatic stabilizer?

Answer 1

Ans