ECON 102 Lecture Notes - Lecture 4: Potential Output, Ceteris Paribus, Fiscal Policy

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19 Aug 2016

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Chapter 22: adding government and taxes to the short run graph. Government purchases: of goods and services (g) such as public servants and construction. Transfer payments: affect aggregate expenditure indirectly thourhg the households spending after the receipt of such payments. Assumption: g is a autonomous respect to y. Any change in g is due to government policy decision. Net taxes (t) are total tax revenues net of transfer payments. While taxes reduce households disposal income, transfer payments increases it. Net taxes are given by: t = ty, where t is the net tax rate and is independent of y (note that only t is independent of y. Also note that t measures an increase in t due to increase in y. The budget balance is the difference between g and t. If g < t: a budget surplus. If g > t: a budget deficit.

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Assume that the equations below describe the expenditures within a particular macroeconomy and that these equations conform to the assumptions we've made in the lecture regarding the fixed price level Aggregate Expenditure model. All values for expenditure and income are dollar amounts, but for simplicity, we've dropped the $ below.

C = 0.8(DI) + 1000	C = Consumption expenditure, DI = Disposable Income
I = 2000	I = Investment expenditure
G = 1000	G = government expenditure
X = 1600	X = spending on exports
M = 1800	M = spending on imports
DI = Y - T	Y = real GDP, T = tax revenues/>
T = 1000
Yp = 12000	Yp = Potential GDP

Given the equations above, we can describe the GDP, government budget, and net exports in this economy. Select three characteristics from the list below which accurately describe this economy. Note that there is no partial credit on this question. I.e., your answer will either be all correct, or all wrong.

	a.	inflationary gap
	b.	recessionary gap
	c.	no output gap
	d.	government budget surplus
	e.	government budget deficit
	f.	balanced government budget
	g.	trade deficit
	h.	trade surplus
	i.	net exports of zero

pucearmadillo585

The Modified Keynesian Model

Y = C + I + G + X â IM â¦ equilibrium condition in a 4-sector model where:

C = 150 + 0.9DI â¦ consumption function

I = 50 â¦ autonomous investment

G = 100 â¦ autonomous government spending

X = 200 â¦ autonomous exports

IM = 100 â¦ autonomous imports

And also:

DI = Y â T + Tr T = 0 â¦ autonomous taxes

Tr = 0 â¦ autonomous transfer payments

YF = 5000 â¦ full-employment Y

1. Solve for the equilibrium level of real output/income (Y*) in this economy.

2. Given the model above, net exports equal $________. Does this represent a trade deficit or trade surplus?

3. Given the model above, the federal budget has a (deficit/surplus) equal to $________.

4. What is the value of the MPC? â¦ the value of the MPS?

5. Calculate the âoversimplifiedâ expenditure multiplier.

6. Suppose that full-employment (YF) equals $5000. Is there a recessionary or inflationary output gap?

7. (Refer to question â6â.) How much is the gap equal to?

8. Suppose the government chooses to eliminate the gap by using expansionary fiscal policy (i.e., increasing G). Given the numbers above, by how much would government spending (G) need to increase to achieve the goal of full-employment?

9. Suppose instead that the government decided to lower taxes to eliminate the output gap in question â6â. How much would taxes need to fall to achieve the goal of full-employment?

10. Which action (raising G or lowering T) has the largest effect on the federal budget deficit and the national debt?

11. Suppose the national debt equaled $6000 before the tax cut (refer to question â9â). What would be the value of the national debt after this policy action?

azurellama883

Suppose that the economy of Freedonia obeys the following relationships:

C = 100 + 0.6(Y ï¿½ T)

I^P = 150

G = 250

NX = 120

T = 200

a. Find the numerical equation relating to planned aggregate expenditure (PAE) to output (Y).

b. Calculate short-run equilibrium output, showing all calculations. What is the government budget balance? Does Freedoniaï¿½s government have a budget surplus or a budget deficit?

c. What is the effect of an increase in government purchases from G = 250 to G = 300 on GDP (Y)? Solve for the new level of equilibrium output. What is the multiplier? Show your work.

d. Suppose that the government simultaneously increases net taxes by 50 (that is, continue to assume that government purchases have increased by 50, as in part (c)). Calculate the new level of equilibrium output, showing your work. What is the new government budget balance? How has it changed from (b)? Does Freedoniaï¿½s government have a budget surplus or a budget deficit?

e. Assume that the equilibrium output found in (b) above is the potential output (Y*) of this economy. After the rise in both government purchases (in (c)) and net taxes (in (d)), what is the output gap in percentage terms? Is this an expansionary gap or a recessionary gap? If the natural rate of unemployment is 6%, use Okunï¿½s law to calculate what the actual unemployment rate must be.

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ECON 102 Lecture Notes - Lecture 4: Potential Output, Ceteris Paribus, Fiscal Policy

ECON 102 Full Course Notes

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