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Chapter 5 Study Practise with Answers

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ECON 2450
Frank Marchese

Answers to Practice Exercises for Chapter 5 1. In both cases the consumption function is given by D C = C 0+ C y D In the case that we have been discussing in class Y = (1-t)Y, and thus the consumption function becomes C = C 0+ C y1-t)Y In the exercise, we have that disposable income includes not only taxation but also transfers (e.g. welfare payments): Y = TR + (1 – t)Y. D (a) In this case disposable income is Y = TR + (1 –0t)Y and thus the consumption function boils down to C = C 0 + CyTR 0 C (y-t)Y Transfers in this case are just a constant term: the amount of transfers is independent of the level of income in the economy. The consumption line will have exactly the same slope as the one we discussed in class but the intercept will be higher: (C0+ C yR )0instead of C . 0 D (b) In this case disposable income is Y = TR + (1 –0t - TR )Y andythe consumption function boils down to, C = C 0+ C yR +0C (1yt - TR )Y y Transfers in this case also depend on income. There is a baseline level of transfers that is independent of the level of income (term TR ). However 0 the higher the level of income the lower the transfers that will be given (term TR Y)ywhere - TR measyres how much transfers will fall if income rises by one dollar. In this case the intercept of the consumption function is (C + C TR ) and the slope (1-t - TR ) rather than (1-t), i.e. less 0 y 0 y steep. 2. (a) An increase in corporate profits taxes would reduce the poten
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