Graphically illustrate the effects of tax cut on aggregate

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Reference no: EM13151218

Consider a one-period macroeconomic model with the following features. The representative consumer chooses consumption, C and leisure, l, and takes taxes, T, dividends, ?, the wage rate, w, and her endowment of time, h, as given. The representative firm chooses the demand for labour, Nd, to maximise profits. The firm uses the standard production function, zF (K, N d), where z denotes TFP and K is the given stock of capital, and takes the wage rate, w, as given. The government consumes G and collects lump-sum taxes, T, and runs a balanced budget. The wage rate adjusts to clear all the markets in the economy. (a) Graphically represent a competitive equilibrium in which consumer’s preferences and representative firm’s technology are brought together in a single diagram. Explain. [10 marks] (b) Suppose that the government cuts taxes, T . Explain and graphically illustrate the effects of the tax cut on aggregate output, consumption, employment and the real wage. Discuss these effects with reference to substitution and income effects. To what extent are the effects of the changes in taxation compatible with short-run business cycles? [10 marks] (c) Suppose there is an increase in the Total Factor Productivity, z. Ex- plain and graphically illustrate the effects of this increase on aggre- gate output, consumption, employment and the real wage. Discuss these effects with reference to substitution and income effects. (d) How do the effects of an increase in z compare with long-run growth as observed in the data?

Reference no: EM13151218

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