Question

In the above question, calculate the effect on the output of a 10% increase in transfers, and a 10% increase in lump sum taxes. Compare the effect of the two.

Answer 1

MPC = 0.80

$\overline{C}$ = 20

I = 30

G = 50

TR = 100

$\Delta$ TR = 10

Equilibrium level of income

$=\frac{1}{1-c}[\overline{C}+cTR+I+G+\Delta TR]$

$=\frac{1}{1-0.80}[20+0.80\times 100+30+50+0.80\times 10]$

$=\frac{188}{20}\times 100=940$

Change in income = 940 - 900

= 40

Increase in lump sum taxes, $\Delta T$ = 10

Change in income $=\Delta T\times \frac{-c}{1-c}$

$=-10\times \frac{0.80}{0.20}$

$=-10\times 4$

$=-40$

Conclusion: Increase of 10% in transfers will raise the income by 40 and increase of 10% in tax will lead to fall in the income by 40.