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ECON 1P92 (65)

Chapter 22.docx

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Marilyn Cottrell

Chapter 22: Introducing Government  Government is and important variable in the economy> Fiscal Policy:  Government expenditures or purchases  Taxation Government Spending  G is part of desired AE Transfer payments: e.g. pensions  not government purchases  only a flow of funds from government to household  affects disposable income and household spending Tax Revenues  Net taxes, T:  Total revenue minus total transfer payments Tax rates are autonomous policy variables, but revenues vary with GDP: T = t Y Where t = marginal propensity to tax. Note: t includes all taxes, So when Y rises by $1, tax revenues rise by t x $1. The Budget Balance: [ T – G ]  G is autonomous  Tax rates are induced  [ T - G ] revenue minus expenditures  If T > G – budget surplus  If T < G – budget deficit As Y increases, T rises  Tax revenue rise  Transfer payments fall Provincial and Municipal Governments  G includes all levels of government in desired AE in public saving  [In Canada – combined purchases of provincial and municipal governments is larger than federal government ] Net Export Function Exports: X  Autonomous with respect to Canadian national income. Imports: IM = mY  Rises as national income increases  Not autonomous  Induced or depends on GDP Marginal propensity to import:  Change in imports caused by a $1 change in GDP  Change in m / Change in y  MPM = m = 20/100 = 0.2 Net export function: NX = X – IM  Falls as national income rises  X constant  IM increase as GDP [ Y ] increase If X > IM:  Foreigners buy more C$  To buy exports  Canada accumulates more foreign currency  Uses foreign currency to buy foreign income-earning assets  Similar to investment ( I )  Produced future income for Canadians If IM > X:  Canadians sell more C$  Buy more imports than foreigners  Canada’s trading partners accumulate C$  C$ used to buy Canadian assets  Liability for Canada  Income will flow to foreigners NX function holds constant:  Foreign national income  Domestic and foreign prices  Exchange rate If any of these change, NX changes Shifts in the Net Export Function Foreign income: If foreign incomes increase  Ceteris paribus, Canadian exports [ X ] increase  Shifts up NX function Domestic and foreign prices: A rise in Canadian prices relative to foreign prices:  Foreign remains constant Canadian is increasing  Reduces Canadian exports  X function shifts down  Imports increase – cheaper  IM function rotates upward  NX function shifts down and gets steeper Exchange rates cause relative prices to change. Appreciation of Canadian dollar:  Increases Canadian prices relative to foreign prices Depreciation of Canadian dollar: Decreases Canadian prices relative to foreign prices Equilibrium GDP  Where desired aggregate expenditure ( AE ) equals national income ( Y )  AE =Y Include:  Government ( T-G )  Net exports ( NX = X – IM ) Adjust consumption:  With government national income ( Y ) is not the same as disposable income ( Yd ) * Yd = Y – T * With taxes:  Disposable income ( Yd ) < national income ( Y )  Suppose T = 0.1Y. (Taxes=10% of Y)  Then, Yd = Y – 0.1Y = 0.9Y (Disposable income = 90% of Y)  Consumption function (out of Yd) C = 10 + 0.8 Yd C = 10 + (0.8)(0.9Y) C = 10+ 0.72 Y With income taxes:  MPC out of national income (0.72)  Is less than the MPC out of disposable income (0.8)  MPC
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