Suppose that the autonomous level of consumption is $40 billion per year, the marginal propensity to consume is .9, investment demand is $1200 billion, government spending is $900 billion, and lump-sum taxes are $800 billion per year. Let exports be equal to imports at $750 billion.
Suppose the government wants to switch from a lump-sum tax to an income tax, so that T = t*Y. This is a so-called "Flat Rate" tax because everyone pays the same rate no matter how much they make.
A. Suppose the government gets rid of the lump-sum tax and initially sets the income tax rate at 7%. What happens to short-run equilibrium GDP?
B. What happens to medium-run and long-run GDP as a result of the switch?