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Chapter 13: Q4. (page 284)
Refer to the following table for Waxwania:
What is the marginal tax rate in Waxwania? The average tax rate? Which of the following describes the tax system: proportional, progressive, or regressive?
The marginal tax rate is 20%, and the average tax rate is also 20%. The tax system is proportional.
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Assume that a hypothetical economy with an MPC of .8 is experiencing a severe recession. By how much would government spending have to rise to shift the aggregate demand curve rightward by $25 billion? How large a tax cut would be needed to achieve the same increase in aggregate demand? Determine one possible combination of government spending increases and tax decreases that would accomplish the same goal.
What do economists mean when they say Social Security and Medicare are “pay-as-you-go” plans? What are the Social Security and Medicare trust funds, and how long will they have money left in them? What is the key long-run problem of both Social Security and Medicare? To fix the problem, do you favor increasing taxes or do you prefer reducing benefits?
Briefly state and evaluate the problem of time lags in enacting and applying fiscal policy. Explain the idea of a political business cycle. How might expectations of a near-term policy reversal weaken fiscal policy based on changes in tax rates? What is the crowding-out effect, and why might it be relevant to fiscal policy?
Refer back to the table in Figure 12.7 in the previous chapter. Suppose that aggregate demand increases such that the amount of real output demanded rises by \(7 billion at each price level. By what percentage will the price level increase? Will this inflation be demand-pull inflation, or will it be cost-push inflation? If potential real GDP (that is, full-employment GDP) is \)510 billion, what will be the size of the positive GDP gap after the change in aggregate demand? If government wants to use fiscal policy to counter the resulting inflation without changing tax rates, would it increase government spending or decrease it?
| Real Output Demanded (Billions) | Price Level (Index Number) | Real Output Supplied (Billions) |
| \(506 | 108 | \)513 |
| 508 | 104 | 512 |
| 510 | 100 | 510 |
| 512 | 96 | 507 |
| 514 | 92 | 502 |
(For students who were assigned Chapter 11) Assume that, without taxes, the consumption schedule for an economy is as shown below:
| GDP, Billions | Consumption, Billions |
| \(100 | 120 |
| 200 | 200 |
| 300 | 280 |
| 400 | 360 |
| 500 | 440 |
| 600 | 520 |
| 700 | 600 |
Graph this consumption schedule. What is the size of the MPC?
Assume that a lump-sum (regressive) tax of \)10 billion is imposed at all levels of GDP. Calculate the tax rate at each level of GDP. Graph the resulting consumption schedule and compare the MPC and the multiplier with those of the pretax consumption schedule.
Now suppose a proportional tax with a 10 percent tax rate is imposed instead of the regressive tax. Calculate and graph the new consumption schedule, and calculate the MPC and the multiplier.
Finally, impose a progressive tax such that the tax rate is 0 percent when GDP is \(100, 5 percent at \)200, 10 percent at \(300, 15 percent at \)400, and so forth. Determine and graph the new consumption schedule, noting the effect of this tax system on the MPC and the multiplier.
Use a graph similar to Figure 13.3 to show why proportional and progressive taxes contribute to greater economic stability, while a regressive tax does not.
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