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Consider two identical economies A and B that abide by a standard Keynesian economy with partially sticky prices.
5. Consider two identical economies A and B that abide by a standard Keynesian economy with partially sticky prices. Suppose the economy A is populated by agents with adaptive expectations and economy B is populated by agents with forward looking expectations. More specifically, Type A agents construct price expectations according to Pet = Pt−1 and agent B has Pet = Et(Pt+1), in which Et(Pt+1) represents current expectations of next period’s price level .Suppose both governments announce today a marginal income tax τ that will be paidentirely by the workers. The tax still needs to be approved by both houses of Congress and the process is enacted in the next period (t+1).If the only goal of the income tax is to maximize revenue, say, Revenue t = τYt. What can we say about economies A and B at time t (i.e., in the short run)?
A. Tax revenues will be higher in A. The timing in the Congress decision makes no difference.
B. Tax revenues will be higher in B. The timing in the Congress decision makes no difference.
C. Tax revenues will be higher in A. If Congress B wants the same level of revenues as in A then they need to surprise the agents.
D. Tax revenues will be higher in B. If Congress A wants the same level of revenuesas in B then they need to surprise the agents.
