Question

3. Reducing tax rates: Suppose the government decides to reform the tax system to reduce the marginal income tax rate across the board. Explain the effect on wages, the employment-population ratio, and unemployment. 4. A positive oil shock: Suppose scientists discover a new way to extract oil from deposits that were previously thought to be unrecoverable. The extra supply of oil leads oil prices to decline by $5 per barrel. Explain the effect on wages, the employment-population ratio, and unemployment—all for the overall economy.

Answer 1

3. Reducing tax rates: If the government decides to reduce marginal income tax rate:

Effect on Wages: Since tax will decrease across the board, the wages that will reach the pocket of workers will increase

Effect on Employment - Population Ratio: Tax cut increases demand of goods and consumption, which in turn increases employment opportunities due to increase in production. This implies the Employment to population ratio will increase.

Effect on Unemployment: Since demand increases due to increase in disposable income, new job will be created due to increase in production, therefore Unemployment will decrease.

4. A positive oil shock :

Effect on Wages: A dip in oil price will lead to increase in wages due to increase in demand.

Effect on Employment: Population ratio: Drop in oil prices will lead to increase in employment due to increase in demand and overall boost in production in the economy.

Effect on Unemployment: Due to increase in demand, there will be an increase in job creation and hence Unemployment will decrease.