What happens if we introduce a tax on consumption (you can think about a VAT type tax) with 20% tax rate in the WS–PS model?

Question

Accepted Answer

The split of the production between firms and workers is unaffected by taxation, i.e. shares σ and (1–σ) are the same as without taxation.

Accepted Answer

The government recives one sixth of output, firms and workers split the rest.

Answer

Equilibrium employment increases and real wages drop.

Answer

Workers care about price before taxes (price that are received by the firm), so we plot this price on the vertical axis in the WS-PS model.

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