Note: Please clearly label your answers submission sheet by…
Note: Please clearly label your answers submission sheet by section (Parts 1-4) and question number so it is straightforward to grade. Part 2: Cutting Taxes (36 points, 3 each) The Republican controlled congress is currently proposing various bills to cut taxes. Assume we permanently cut labor income taxes in our model. Assume that the income effect on labor supply is the same as the substitution effect on labor supply, like most empirical evidence suggests. Assume that households are PIH and they care about the PVLR of their after-tax earnings when making consumption decisions. Let’s first consider the short-run and then the long-run adjustment under the self-correcting mechanism. 1. In the short-run: Consumption will rise Consumption will be unchanged Consumption will fall The effect on consumption is ambiguous 2. In the short-run: Prices will rise and output will rise Prices will rise and output will be unchanged Prices will rise and output will fall Prices will fall and output will fall Prices will fall and output will be unchanged Prices will fall and output will rise The effect on prices and output is ambiguous 3. In the short-run: Employment will be unchanged Employment will increase Employment will decrease The effect on employment is ambiguous 4. In the short-run: The IS Curve shifts right and the LM curve shifts right The IS curve shifts right and the LM curve doesn’t shift The IS curve shifts right and the LM curve shifts left The IS curve shifts left and the LM curve shifts right The IS curve shifts left and the LM curve doesn’t shift The IS curve shifts left and the LM curve shifts left 5. In the short-run: Investment rises and consumption falls Investment rises and consumption is unchanged Investment rises and consumption rises Investment falls and consumption falls Investment falls and consumption is unchanged Investment falls and consumption rises 6. In the long-run (comparing to the initial point): Y* will rise Y* will be unchanged Y* will fall The effect on Y* is ambiguous 7. In the long-run (comparing to the initial point): Prices will fall Prices will stay the same Prices will rise The movement in prices is ambiguous 8. In the long-run (comparing to the initial point): The after tax real wage will rise The after tax real wage will be unchanged The after tax real wage will fall The effect on after tax real wages is ambiguous 9. In the long-run (comparing to the initial point): Investment rises and consumption falls Investment rises and consumption is unchanged Investment rises and consumption rises Investment falls and consumption falls Investment falls and consumption is unchanged Investment falls and consumption rises 10. In the long-run (comparing to the initial point): The structural deficit rises The structural deficit is unchanged The structural deficit declines The effect on the structural deficit is ambiguous When these tax cuts were first implemented in 2017, they were set to expire in 2025. This means that under current law, taxes are set to increase at the end of 2025. However, “temporary” tax cuts in the past have typically been extended, so many households might be expecting the tax rates from 2017 to continue into the future. Suppose that the 2017 tax cuts get extended through new legislation this year, but that people already expected those tax rates to continue before this new legislation was passed. 11. In the short-run: Consumption will rise Consumption will be unchanged Consumption will fall The effect on consumption is ambiguous 12. In the short-run: Output will rise Output will be unchanged Output will fall The effect on output is ambiguous