Consider an economy with one representative consumer, one representative firm and the government. Suppose that the consumer has one unit of labor and she supplies her labor inelastically. That means she works a fixed amount N, no matter what the wage is. The consumer's budget constraint is c = WN + Tt, and it is firm's profit. To simplify the question, assume the firm uses only labor input with the production function y = 2N1-4. The firm must pay a proportional tax on its revenue at tax rate Ty. The government funds its spending g from the corporate tax. a. Set up and solve for the firm's labor demand. Use diagram to determine the wage and employment in equilibrium. Now suppose that the government reduces the corporate tax. The corporate tax rate becomes t2 <11. b. What happens to the firm's labor demand? On the same diagram from (a), show the new labor market equilibrium. c. What happens to the consumption and output in equilibrium? Consider the fact that to fund the tax cut, the government must either reduce spending or increase some other tax. d. Suppose that the government reduces government spending by the amount needed to fund the tax cut. Now what happens on net to wages, employment, consumption and output?

Answer for the question :

Consider an economy with one representative consumer, one representative firm and the government. Suppose that the consumer has one unit of labor and she supplies her labor inelastically. That means she works a fixed amount N, no matter what the wage is. The consumer's budget constraint is c = WN + Tt, and it is firm's profit. To simplify the question, assume the firm uses only labor input with the production function y = 2N1-4. The firm must pay a proportional tax on its revenue at tax rate Ty. The government funds its spending g from the corporate tax. a. Set up and solve for the firm's labor demand. Use diagram to determine the wage and employment in equilibrium. Now suppose that the government reduces the corporate tax. The corporate tax rate becomes t2 <11. b. What happens to the firm's labor demand? On the same diagram from (a), show the new labor market equilibrium. c. What happens to the consumption and output in equilibrium? Consider the fact that to fund the tax cut, the government must either reduce spending or increase some other tax. d. Suppose that the government reduces government spending by the amount needed to fund the tax cut. Now what happens on net to wages, employment, consumption and output?"

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Explanation:

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