Effect of an increase in taxes

Begin with the Planned Expenditure equation:

Draw the PE line on the graph. Draw the Y=PE line (equilibrium line) on the graph. Mark the
equilibrium point.
Suppose taxes increase from T1 to T2. Which component in PE will this affect?
Old PE =
New PE =
Now draw the new PE line on the same graph below. Mark the new equilibrium point. Is it
higher or lower?

After the increase in taxes, at Y1, there is __________________________

This is a signal for firms to _____________________________________________
Therefore, output ________________________________

How much does output change?

Equilibrium output:

Take the derivative with respect to T:

Let 𝛼 " denote the tax multiplier.

Definition of 𝛼 " :

Example: If MPC = 0.8, then

The tax multiplier is:

• negative: A tax increase reduces C,
• is greater than one (in absolute value): A change in taxes has a
• _______________ than the government expenditure multiplier.