The Canadian Economy with an Increase in Personal Income Tax

Rates
December-03-08
8:34 AM

AS
AD0
Income Price

AD1

Equilibrium 2
Y0 P0

Y1 P1
Full Employment, Full Output
Equilibrium 1

Q1 E1 Q0 E0

OUTPUT EMPLOYMENT

Economic Model: How will an increase in personal income tax rates effect the economy

To start we must show some kind of connection between tax rate and aggregate demand.
This is now a direct relationship like government spending was.

Now lets assume there is an increase in personal income tax rates how will this affect the graph?

Recall: YD = Y-T
T = f(Y)
T = t1Y

Therefore:

If T1 ↑ T2
↓ YD

C = F(yd)

C= ↓

AsC ↓ AD ↓ to AD1: Because AD = C+I+G+X-M

This will cause the curve to shift to the left.

Now there will be an new equilibrium where AD1 crossing the AS at that point the economy is in
equilibrium where the:

• Output level decreases from Q0 to Q1

• Employment decreases from E0 to E1
• Income level decreases from Y0 to Y1
• Price level decreases from P0 to P1

In conclusion

AS t ↑ Yd ↓ C ↓ AD ↓ Q ↓ Employment ↓ Y ↓ P ↓

Unit 3 - Fiscal Policy Page 1