Income and Spending

Question 1

Discuss the relation between income taxes and the multiplier in the case of the government sector

Answer 1

Income taxes lower the multiplier. This happens because they reduce the induced increase in consumption due to changes in income and the inclusion of taxes

Question 2

What is The Consumption function equation?

Answer 2

C= Cbar + cY

Question 3

Discuss the marginal propensity to consume

Answer 3

It’s the increase in consumption per unit increase in income

Question 4

What is the saving function equation?

Answer 4

s= -cbar + (1-c)y

Question 5

What is disposable income

Answer 5

The income left after dealing with transfer reserves and taxes

Question 6

Show the graph of aggregate demand and consumption function

Answer 6

Check Figure 9.1 in the chapter

Question 7

The formula for equilibrium output

Answer 7

y= 1/1-c* Abar

Question 8

Talk about the saving and investment topic here and derive its equation

Answer 8

1. Y C+S
2. Y C+I (With no government and foreign trade)
   from the above two equations.
   C+I=C+S
   So, S=I
   If we include government and foreign trade,
   AD=Y,
   C+I+G+NX=C+S+TA-TR
   S+ (TA-TR-G)- NX=I

Question 9

Discuss Multiplier here

Answer 9

The multiple in equilibrium output (1-c) from equation 1/1-c *Abar is the multiplier

The multiplier is the amount by which equilibrium output changes when autonomous aggregate demand increases by 1 unit.

multiplier (a)= 1/1-c
The above equation shows, the larger the margin propensity to consume, the larger the multiplier. The diagram 9.3

Question 9

Discuss the equation of AD in The Government Sector along with a change in equilibrium income

Answer 9

AD= C+I+G+NX
AD= Cbar+ cYD + Ibar+Gbar+NXbar
AD= Cbar+ c(y-TAbar+ TRbar) +Ibar+Gbar+NXbar
But when taxes are not autonomous, then taxes are some proportion of income

TA= tY
In such a case,
AD= Cbar+ c(y-ty+ TRbar) +Ibar+Gbar+NXbar
AD= Abar + c(1-t)y

Change in Equilibrium Income

Y=AD
Y=Abar + c(1-t)y
Y= 1/1-C(1-t)* Abar

Question 10

What is the equation of budget surplus in Income and Spending?

Answer 10

BS= tY-Gbar-TRbar

Question 11

Draw the Budget Surplus diagram

Answer 11

Figure 9.6

Question 11

Why is the budget surplus figure sloping upwards?

Answer 11

This happens because of a mechanism where, when the aggregate demand increases, the economy’s income tends to increase, which ultimately increases the tax rate(t) that is charged on the income of the consumers. This way, the government receives a surplus in their revenue from imposing taxes, thus having a budget surplus. Because of this, the budget surplus shoots upward

Question 12

When the government spends more (fiscal policy)

Answer 12

Imagine the government buys more stuff or builds more roads (government spending increases).

This makes demand go up.

So businesses start making more things to match the demand.

This leads to more jobs and higher income in the economy.

The graph in the image shows how income increases from Y₀ to Y′ because of this extra spending.
Key idea: More government spending → more demand → more production → more income.

Question 13

How much income increases (the multiplier) from fiscal policy pov

Answer 13

When the government spends $1, the total income increases by more than $1.
Why? Because when people earn more, they spend more too.
This “extra effect” is called the multiplier. explain this again
Example: If the multiplier is 2.5, then a $1 increase in government spending increases income by $2.50.

The Formula:
Δ𝑌=𝛼𝐺×Δ𝐺

ΔY =aG×ΔG
Where:

ΔY = Change in income

ΔG = Change in government spending

αG = The multiplier
How to calculate the multiplier (αG)?

αG= 1/ 1-c(1-t)

​

Where:

c = Marginal Propensity to Consume (MPC) → how much of extra income people spend

t = Tax rate → the % of income that goes to taxes

💡 Simple Meaning of the Formula:
If people spend more from their extra income (higher c), → bigger multiplier

If taxes are high (higher t) → people have less to spend → smaller multiplier