Question

Describe Fiscal Policy. Consider an economy where government charges 20% of an individual’s income as taxes (i.e. T = 0.2Y). Consider the consumption function of the form C = e + f(DI), using the proportional tax policy mentioned above, calculate the multiplier for this economy in terms of MPC and taxes introduced. Use DI = Y-T(10 points)

Answer 1

Fiscal policy refers to the economic policy that is used by the government of a particular nation to influence various macroeconomic variables such as inflation, employment, demand and services and economic growth through government spending and taxes.

Determination of multiplier:

ΔY = [MPC (ΔY - 0.2ΔY)] + ΔA

ΔY = MPCΔY - 0.2MPCΔY + ΔA

ΔY - MPCΔY + 0.2MPCΔY = ΔA

ΔY [1 - MPC + 0.2 MPC] = ΔA

`(\Delta Y)/(\Delta A)=(1)/(1 - MPC + 0.2MPC)`

`Multiplier=(1)/(1 - MPC + 0.2MPC)`