BLANKS ARE GIVEN IN ORDER

7. Algebraic treatment of taxes and fiscal policy Consider a small country that is closed to trade, so its net exports are equal to zero. The following equations describe the economy of this country in bilions of dollars, where Y is real GDP, C is consumption, DI is disposable income, I is investment, and G is oovernment purchases: Y=C+I+GC=100+0.75DIG=50I=80 Assume that this economy initially has a fixed tax and that net taxes (taxes minus transfer payments) are 540 billion. Disposable income is then (Y40). Aogregate output demanded is Suppose the government decides to increase spending by $10 billion without raising taxes. Because the expenditure multiplier is this will increase the economy's aggregate cutput demanded by Now suppose that the government switches to an income tax, which is a type of variable tax, of 5%. Because consumers retain only 95% of each additional dollar of income, disposable income is now 0.95Y, In this case, the economy's aggregate output demanded is Given an income tax of $%, the expenditure multiplier is approximately Therefore, if the govemment decides to increase spending by $10 bilion wikhout rabing tax rates, this would increase the economy's agoregate output demanded by approximately A s10 bilion increase in govenment purchases will have a larger effect on output under a Assume that this economy initially has a fixed tax and that net taxes (taxes min (Y40). Aggregate output demanded is Suppose the government decides to increa I $10 billion without rais increase the economy's aggregate output $500 billion Now suppose that the government switche additional dollar of income, disposable inc $800 billion tax, which is a type of 5Y. In this case, the iplier is this will d by pe o e, plier fill ha outp illion. Disposable income is then $800billion$500billion is will nsumers re of each emanded is 3.5 sing taxes 0.75 hich is a 4 variable t In this economy 3 kimately Therefore, y'saggregate output dema imately case, the economy's aggregate output demanded is . Therefore, regate output dema ton output under a