Econ 103

b) the overall effect on labour in the economy , depends on the income or substitution effect, if income is stronger the labours will increase and vice versa.

c) the output will increase as due to the cut in taxes , the disposable income has increased , so people will spend more on consumption.

d) if corporate tax is reduced and we look at the solow model framework, firms can invest more in the activities that increases output or in the ones that improves the technology and so you grow. the output gap will reduce in this case  

2 a) if ricardian equivalence does not hold , a reduction in taxes would increase the disposable income with te consumers , hence the demand and output.

b) IS shifts to IS'

c) both would increase

d) investments would increase , pushing IS further to the right , output gap and inflation increase.

3 a)

LM will be increased .

4) you are reducing the taxes and still have a high expenditure. i will lead o a pressure being created on the consumers later as they will only have to bare increased taxes in the future . the goverment will lose the confidence of the people and as a reult whaever governmen wants them to do , hey will do the opposite in anticipation of the worse .

2.a) A reduction in income taxes increases the spending power of the consumers. The lower rate of taxes leaves more money in the hands of the consumer , thus increasing their purchasing power.

b) Since the workers are better off with a lower tax rate their spending increases. This will shift the Aggregate Demand (AD ) to the right. The economic growth increases because the consumer spending is a component of AD.

The shift in AD is possible only if the tax cuts are financed by the government borrowing. The government is injecting unused resources to the circular flow. But if the tax cuts are financed by spending cuts AD will not increase because some people are better off from the tax cut, but others will cut their spending due to a decrease in welfare payments .

c) The difference between the actual output and the potential output of an economy is known as output gap. It can be positive or negative.

When the consumer spending increases there is a high demand for goods and services in the economy and this creates a positive output gap.

This means the real GDP exceeds the potential GDP. The prices are pushed up causing inflationary gap

d) In the long run the government use fiscal policies to close the output and inflationary gap. When there is a positive output gap the government adopts contractionary or tight fiscal policy to reduce the demand and combat inflation through lower spending.

e) When the corporate taxes are reduced along with a reduction in income tax it will have a multiplier effect on the output and inflationary gap . This is because a decrease in corporate taxes will also boost the production process in the economy.

4. a. Loanable funds is the amount of money available for borrowing. The supply of loanable funds is based on savings and the demand for it based on borrowing. The interaction between the supply of savings and the demand for loans determines the real interest rate and how much is loaned out. Firms are the main borrowers of loanable funds, but they will only borrow if they can make an investment in real capital to produce a product or service that will have a higher return on investment than the interest rate being paid on loanable funds. In the present US scenario, when the tight monetary policies are relaxed, there is more loanable funds and hence investment that will bring in more revenue in terms of interest rates.

In the future, this will bring-in more investments and result in higher GDP and lower deficit though temporarily the deficit rates may increase as a result of increased spending and relaxed cuts

The financing of tax cuts significantly affects its impact on long-term growth. Tax cuts financed by immediate cuts in unproductive government spending could raise output, but tax cuts financed by reductions in government investment could reduce output. If they are not financed by spending cuts, tax cuts will lead to an increase in federal borrowing, which in turn, will reduce long-term growth. The historical evidence and simulation analyses suggest that tax cuts that are financed by debt for an extended period of time will have little positive impact on long-term growth and could reduce growth.