Given a basic three sector Keynesian model, Y = C + I + G, where investment is a

Question

Given a basic three sector Keynesian model, Y = C + I + G, where investment is a function of interest rates and government spending and taxes are exogenous, I = Io, G = Go and Tx = Txo, the effect of an increase in taxes would be to:

shift the consumption function downward by the amount of the increase in tax

shift the consumption function downward by more than the amount of the increase in the tax

shift the consumption function downward but by less than the amount of the increase in the tax

not shift the consumption function

Explanation / Answer

The effect of an increase in taxes would be to:

shift the consumption function downward but by less than the amount of increase in the tax.

explanation: Generally we know with an increase in tax, there is a direct effect on the disposable income, however, the reduction in spending is not dollar to dollar, because a portion of the taxes comes from savings.

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