Question-

Consider a closed economy model given by the following equations

Y= C+I+G

C=160+0.8Yd

Yd=(1 - t) Y - Z

Investment  and government spending are exogenous and each equals 200. The tax system has two components : a lump sum tax denoted by Z and an income tax of rate t

a)  Suppose Z equals 200 and t is 0.25. Find the level of income that satisfies spending balance. How much does government collect in taxes at that level of income? What is the level of government saving?

b) Suppose the lump sum tax is reduced to 100. Find the new level of income consistent with spending balance. What is the lump-sum tax multiplier? What are the new levels of tax collections and government saving?

c) Comparing your answers in part a and b does the tax cut increase or decrease tax receipts ? By how much? Explain why tax receipts do not simply fall by 100 with the cut in lump sum taxes.

d) One of the arguments of supply - side economist in the early 80's was that a tax cut could actually reduce the budget deficit . Can that happen with a lump sum tax cut in the model used in this problem? Does the spending balance model ignore factors that the supply siders think are important for this problem? If so name them.