DSE QUESTION 42.

[DEEPIKA]

HI AMIT,
Q 42. Suppose the economy is at less than full potential and consists of aggregate worker and aggregate capitalist with former having high MPC . suppose both agents pay same income tax according to same linear schedule. If govts balance is in balance and a lump sum income transfer is made from capitalist to worker, then the govt's

a budget goes in to deficit.
b budget goes in to surplus.
c income and expenditure  will be unchanged.
d income and exp  will change but budget will stay the same.

I dont know wat exactly linear tax schedule is i am assuming it is a+ y(1-t)

After the transfer workers income would go up and capitalist's would go down. Then for the lumpsome amount more proportion would be spent in form of workers consumption which would increase consumption in the economy. this would imply that pvt saving would decrease as income levels are the same.

y = C +I +G
Now we have more C. constant Y, I and G with decrease in pvt saving.. public saving would go up.. and budget would be in surplus.
I'm not sure, im just fishing after looking at the answer....
pls let me know.

 

[DEEPIKA]

DSE 2010 Q 42 btw....
I think i am close now..
I think its increase in consumption increases income and raises tax base which leads to govt surplus.
I think the less than full unemployment is the key factor here.

[aditi5000]

yes Deepika, you're right. I agree with you. Since income is transferred to the high MPC group, domestic AD grows and with the multiplier effect more income is generated which eventually leads to government surplus because of a wider taxbase