Question: AUTOMATIC STABILIZERS So far in this chapter, we have been assuming that the fi scal policy variable T is independent of the level of income.

AUTOMATIC STABILIZERS So far in this chapter, we have been assuming that the fi scal policy variable T is independent of the level of income. In the real world, however, this is not the case. Taxes typically depend on the level of income, so tax revenue tends to be higher when income is higher. In this problem, we examine how this automatic response of taxes can help reduce the impact of changes in autonomous spending on output. Consider the following model of the economy: C = c0 + c1YD T = t0 + t1Y YD = Y - T G and @ I are both constant.

a. Is t1 greater or less than one? Explain.

b. Solve for equilibrium output.

c. What is the multiplier? Does the economy respond more to changes in autonomous spending when t1 is zero or when t1 is positive? Explain.

d. Why is fi scal policy in this case called an “automatic stabilizer”?

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