Question

2. Refer to the diagram. Under which tax system, the cyclical deficit would be the highest? Lowest? (4 points) Tax Revenue GDP 3. Assume in a closed economy that, at the equilibrium level of income the MPS is 0.20. Suppose government collects taxes of $70 and spends the entire amount. As a result, the equilibrium level of income becomes $420. What was the before-tax equilibrium level of income? (10 points) 4. Consider the following consumption schedule for a closed economy. Assume the government imposes a lump-sum tax of $30. What will become the after-tax consumption schedule? (9 points) Gross Domestic Product (GDP) Consumption (C) $40 100 120 200

Answer 1

Q2) Cyclical deficit basically means that there is a deficit even as the economy is growing (output is increasing). The deficit will be higher if the tax revenues are lower as output increases. This happens when the tax revenue curve is the flattest. Thus, the highest cyclical deficit is under T4. On the other hand, the lowest deficit will be when the tax revenue curve is the steepest. This happens in regime T1 where the cyclical deficit is the lowest.