The following equations describe your economy:

Y = C + I + G

C = c(bar) +cYD

YD = Y + TR – TA

I = I(bar)

G = G(bar)

TA = tY

TR = TR(bar) – rY

(NOTE: c(bar), I(bar), TR(bar)= C-Bar, I-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) Suppose that the government adopts a proposal to impose a tax on transfer payments to its citizens such that TA = t (Y + TR) (note: TR still TR(bar). Using this expression for taxes and the same expression for transfers as given in the model, derive an expression for equilibrium output.

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

Answer rating: 100% (QA)

ANSWER a To derive an expression for equilibrium output lets substitute the given expressions for C ... View the full answer