1. Imagine that the Canadian economy in 2016 could be describedby the following demand determined model:
Consumption: C = a + bYd + θW
Investment: I = I0
Government Purchases: G = G0
Exports: X = X0
Imports: IM = mY
Tax Revenue: T = Ï„ + tY
Where: a is autonomous consumption, b is the marginal propensity toconsume out of disposable income, W is wealth, θ is the marginalpropensity to consume out of wealth, m is the marginal propensityto import, τ are lump-sum taxes, and t is the tax rate.
(a) Algebraically solve for the equilibrium level of nationalincome, the simple multiplier & draw a diagram of theequilibrium. Make sure to show all your steps, and label allimportant points on your graph. Total of 7 Marks (5 marks foralgebra, 2 marks for graph)
(b) The real value of Canadian households’ principal residenceincreased three-fold from 1999-2016 and represented about 36% ofhousehold assets. Discuss (using the aid of a diagram) what wouldhappen if housing prices fell in this economy. Total of 7 Marks (4marks for explanation, 3 marks for graph)
For parts (c) and (d), imagine the Canadian economy ischaracterized by the following parameter values:
Consumption: C = 200 + .75Yd + 0.05W
Investment: I = 350
Government Purchases: G = 75
Exports: X = 125
Imports: IM = 0.2Y
Tax Revenue: T = 100 + 0.1Y
Wealth: W = 1000
The government wants to decrease equilibrium national income by$10 billion using taxation. This model allows two possible taxpolicies: i. Changes to lump-sum taxes (Ï„) ii. Changes to thetax-rate (t)
(c) If the government wanted to decrease national equilibrium by$10billion solely through changes to lump-sum taxes(Ï„), how shouldthey alter their lump-sum taxes? Assume no other changes would takeplace. Complete answers should include both your calculations and adiagram illustrating what is happening. Total of 7 Marks (2 marksfor graph, 5 marks for algebra/explanation)
(d) If the government wanted to decrease national equilibrium by$10billion solely through changes to the proportional tax rate(t),how should they alter their tax rate? Assume no other changes wouldtake place. Complete answers should include both your calculationsand a diagram illustrating what is happening. Total of 7 Marks (2marks for graph, 5 marks for algebra/explanation)
