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Chapter 21: Q9 (page 566)

If an increase in autonomous consumer expenditure is matched by an equal increase in taxes, will aggregate output rise or fall?

Short Answer

Expert verified

Aggregate Output will rise

Step by step solution

01

Introduction 

Aggregate Output is determined where Aggregate Demand = Aggregate Supply.

Aggregate Demand = Consumption + Investment + Government Expenditure + Net Exports ; by households, firms, government, rest of the world.

  • Consumption = Autonomous Consumption + Marginal Propensity to Consume (Disposable Income ie Income - Tax)
02

Explanation 

When autonomous consumption & tax increase by same amount - AD increase by full extent of increase in autonomous consumption, but it decrease by partial extent of 'marginal propensity to consume' (between 0 & 1) due to increase in taxes.

So, consumption overall increases. It implies that AD also increase & increases the equilibrium aggregate output.

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Most popular questions from this chapter

Why does equilibrium output increase as the marginal propensity to consume increases?

In each of the following cases, determine whether the IS curve shifts to the right or left, does not shift, or is indeterminate in the direction of shift.

a. The real interest rate rises.

b. The marginal propensity to consume declines.

c. Financial frictions increase.

d. Autonomous consumption decreases.

e. Both taxes and government spending decrease by the same amount.

f. The sensitivity of net exports to changes in the real interest rate decreases.

g. The government provides tax incentives for research and development programs for firms.

During and in the aftermath of the financial crisis of 2007鈥�2009, planned investment fell substantially despite significant decreases in the real interest rate.

What factors related to the planned investment function could explain this?

Suppose you read that prospects for stronger future economic growth have led the dollar to strengthen and stock prices to increase.

a. What effect does the strengthened dollar have on the IS curve?

b. What effect does the increase in stock prices have on the IS curve?

c. What is the combined effect of these two events on the IS curve?

The fiscal stimulus package of 2009 caused the IS curve to shift to the left, since output decreased and unemployment increased after the policies were implemented.鈥� Is this statement true, false, or uncertain? Explain your answer.
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