METU Department of Economics

ECON102
Spring 2024
Instructor: Eren Gürer
TA: Murad Mustafazade
PROBLEM SET 2
1) Define progressive, regressive, and proportional tax terms. In the following table are five levels
of taxable income and the amount that would be paid at each of the five levels under three tax
laws: X, Y, and Z. compute for each of the three tax laws the average rate of taxation at each of
the four remaining income levels and indicate whether the tax is regressive, proportional, or
progressive.

Tax X Tax Y Tax Z

Average tax Average tax Average tax
Income Tax paid rate % Tax paid rate % Tax paid rate
$10,000 $ 400 4% $ 500 5.0% $300 3%
20,000 800 4 700 3.5 800 4
30,000 1200 4 900 3.0 1500 5
40,000 1600 4 1100 2.8 2400 6
50,000 2000 4 1300 2.6 3500 7

A tax is progressive if its average rate increases as income increases. Such a tax claims not
only a larger absolute (dollar) amount but also a larger percentage of income as income
increases. A tax is regressive if its average rate declines as in- come increases. Such a tax
takes a smaller proportion of income as income increases. A regressive tax may or may not
take a larger absolute amount of income as income increases. (You may want to develop an
example to substantiate this fact.). A tax is proportional if its average rate remains the same
regardless of the size of income. Proportional income taxes are often referred to as flat taxes
or flat- rate taxes because their average rates do not vary with (are flat with respect to)
income levels.
Tax X: Proportional
Tax Y: Regressive
Tax Z: Progressive
2) Suppose that the per capita GDP (i.e. mean income per person) in country A is 50% higher than it
is in country B. Will this necessarily imply that a randomly chosen individual in country A will
generally have higher income than a randomly chosen individual in country B? Discuss why or
why not. No, not necessarily.
We can give a counterexample for this statement. Suppose each country has 3 people. In
country A, two people have incomes of $5000 and the third has an income of $200,000. That
means mean income in country A is $70,000. Alternatively, in country B suppose each
person has an income of $30,000, meaning mean income is also $30,000. Hence, country A
has over twice the mean income of country B. However, if we randomly choose a person
from each country, two out of every three times the person drawn from B will have a higher
income than the person drawn from A. Let us examine this question by using real data. In
the figure below, you can see the Gini indexes of Finland and US from 2003 to 2018.
45

40

35

30

25

20

15

10

0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

United States Finland

According to figure, Gini index of Finland has been lower than the US in the given period,
which means that the income distribution in Finland is more equal than the US. (Note that
as Gini coefficient closes to 0, the income distribution becomes more equal. The extreme
cases, Gini =0 means that everybody gets the same income, and 1 means, one person gives
all). However, that does not mean that a randomly chosen Finnish people is richer than its
American counterpart. Although, Gini gives an information about income distribution, it
does not completely explain the wealth of the society.
 3) Use the following information to fill in the blanks in the table. The economy is a closed economy
without a government. Planned investment spending is determined autonomously. (All figures are
in billions of TL).

Real GDP Consumption Planned Investment Aggregate Planned Expenditures

0 400
1000 2000 400
2000 2800
3000
4000 4400
5000 5200
6000
7000
8000
9000

Real GDP Consumption Planned Investment Aggregate Planned

Expenditures

0 1200 400 1600

1000 2000 400 2400

2000 2800 400 3200

3000 3600 400 4000

4000 4400 400 4800

5000 5200 400 5600

6000 6000 400 6400

7000 6800 400 7200

8000 7600 400 8000

9000 8400 400 8800

 i) Calculate the MPC and MPS.
Δ C 2000−1200
MPC= = =0.8
ΔY 1000−0
MPS=1−MPC=0.2
ii) Determine the equilibrium level of income for this economy.
¿ equilibrium , Y = AE(8000=8000)
AE=C + I =7600+400=8000
iii) If real GDP is 5000, is unplanned inventory investment positive or negative?
How producers will respond?
Unplanned Investment =Y −AE=5000 – 5600=−600
Since producers have unplanned decrease in their inventories, they will
produce more. Thus, we expect an increase in the level of output.
iv) If real GDP is 9000, is unplanned inventory investment positive or negative?
How producers will respond?
Unplanned Investment =Y −AE=9000 – 8800=200
Since producers have unplanned increase in their inventories, they will
produce less. Thus, we expect an decrease in the level of output.

4) (All units are millions of US dollars)

C = 500 +(0.5)YD
I = 100
T = 80
G = 200
i) Solve for the good market equilibrium. (Find equilibrium Y, Z, C, and YD.)
Total demand: Z=C+I+G
Good market equilibrium: Y=Z
So, Y=C+I+G
Remember, YD = Y – T ( YD = disposable income)
Substituting in: Y = 500 + (0.5) (Y – 80) + 100 + 200
Y = (0.5) Y + 760
Y = 1520 (equilibrium output)
YD = 1520 – 80 = 1440 (disposable income)
C = 500 + (0.5) (1440)
C = 1220 (equilibrium consumption)
Z = 1220 + 100 + 200 Z = 1520 (total demand)
 ii) Solve for private saving.
Private Saving : S = YD – C = 1440 – 1220 = 220
Investment : I = S + (T – G ) = sum of private and public saving
I = 220 – 120 = 100
iii) What is the value of marginal propensity to consume (mpc)? What does it mean?
mpc = marginal propensity to consume gives the effect of an additional dollar of
disposable income on consumption. For example, if mpc = c1 = 0.3, this means that
$0.30 of an additional $1 of disposable income will be consumed, and $0.70 will be
saved.
In this problem, mpc = c1 = 0.5. For every $1 additional disposable income increase,
$0.50 will be consumed.
iv) Find the multiplier and autonomous spending. Explain what they mean.

Goods Market Eqm → Y = C + I + G

Y = [c0 + c1 Y - c1 T] + I + G
Y = [ 𝟏/𝟏−𝒄𝟏 ][c0 + I + G - c1 T ]
Multiplier → [𝟏/𝟏−𝒄𝟏] = ( 𝟏/𝟏−𝟎,𝟓) = 2
Autonomous Spending → [c0 + I + G - c1 T ] = 760
Autonomous spending is the part of demand for goods that does not depend on
output.
Autonomous Spending → [c0 + I + G - c1 T ] = 760
Autonomous spending is the part of demand for goods that does not depend on
output. The multiplier tells us how much equilibrium output will change for a given
change in autonomous spending. For example, if investment increases by 500, then
the equilibrium output will rise by 1,000 (500 *2)

PART B: MULTIPLE CHOICE

1) If C = 2000 + .9YD, what increase in government spending must occur for equilibrium output
to increase by 1000?
A) 250
B) 500
C) 100
D) 1000
E) 200
 2) An economy is assumed to be closed when:
A) S=I
B) G=T=0
C) G=T
D) X=M
E) None of the above

3) Suppose the marginal propensity to consume equals .8 (i.e., c1 = .8). Given this information,
which of the following events will cause the largest increase in output?

A) T decreases by 200
B) G increases by 200
C) I increases by 150
D) both A and B
4) Which of the following is a concern of fiscal policy?
A) Policies concerning unemployment compensation, Social Security benefits, welfare
payments, and veterans’ benefits to households
B) Policies concerning taxes
C) Policies concerning government purchases of goods and services
D) All of the above
Refer to the information provided in Table 1 below to answer the questions that follow.

5) Refer to Table 1. At an output level of $400 billion, disposable income equals ________
billion.
A) $400
B) $300
C) $200
D) $100
6) Refer to Table 1. The equilibrium level of output is ________ billion.
A) $600
B) $800
C) $700
D) $1000
7) The government spending multiplier shows:
A) The ratio of the change in government spending to a change in autonomous planned
investment
B) The ratio of the change in equilibrium output to an initial change in government
spending
C) The amount by which government spending changes with changes in the level of
output
D) How government spending is one of those variables that does not change in response
to changes in the economy
8) The tax multiplier is:
A) The ratio of a change in the equilibrium level of output to a change in taxes
B) A negative multiplier
C) Not the same as the multiplier for a change in government spending
D) All of the above

9) Macroeconomic equilibrium occurs when

A) aggregate expenditure = GDP.
B) aggregate expenditure = C+ I + G + net transfers.
C) aggregate income = planned inventories.
D) aggregate expenditure = planned inventories.

10) If the marginal propensity to save is 0.25, then a $10,000 decrease in disposable income will
A) increase consumption by $7,500.
B) increase consumption by $2,500.
C) decrease consumption by $7,500.
D) decrease consumption by $2,500.
11) If firms are more optimistic that future profits will rise and remain strong for the next few
years, then
A) investment spending will fall.
B) investment spending will rise.
C) investment spending will remain unaffected.
D) investment spending will rise and then fall

Answer the following questions according to the curve below

12) The straight line labeled ab is the
A) Lorenz curve.
B) line of equality.
C) line of poverty.
D) line of distribution
13) The poorest 60 percent of households have what percent of the nation’s total income.
A)About 37 percent
B)About 60 percent
C)About 63 percent
D)Precisely 100 percent

14) The Lorenz curve is a representation of

A) a perfectly equal distribution of income
B) a perfectly equal distribution of wealth
C) the percentage of total income earned by each quintile of the population
D) the percentage of poor people in a country
15) The farther away a Lorenz curve for income is from the line of equality, the
A)more equally wealth is distributed.
B)more equally income is distributed.
C)less equally income is distributed.
D)None of the above.