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ECO102H1 (155)
Lecture

# ECO100 - FEB 6 Gov't spending and taxes

4 Pages
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Department
Economics
Course Code
ECO102H1
Professor
James Pesando

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1. Summary ● National Income Determination with fixed prices ○ where desired expenditure = actual output ○ AE = Y ○ AE = C + I + G + X - M ■ Autonomous Expenditure: independent of Y ● intercept on the graph ■ Induced Expenditure: dependent of Y ● slope characteristic of the function 2. Gov’t Spending and Taxes ● 1) Government Spending (G) depend upon ○ Often, political determinants (usually autonomous) ○ “Spend your way out of a recession” ○ To fund G, governments need to collect taxes ● 2) Taxes (T) depend upon ○ National income ■ Marginal propensity to tax = tax rate = t ■ T = t* Y ○ Taxes will indirectly impact AE through consumption ■ Impacts consumers ● 3) Disposable income: YD = Y - T ○ Amount of income consumer actually has after paying taxes ○ Should update the C function where the gov’t exists ■ C = C0 + C1 (YD) ● C0: Autonomous consumption ● C1: Marginal propensity to consume of disposable income ■ C = C0 + C1 (Y-T) ● 4) Budget Balance: Total tax revenue less total government expenditure ○ T - G ○ If T - G: Balanced Budget ■ no debt, no extra money ○ If T > G: Budget surplus ○ If T< G: Budget deficit 3. Extended Model Example ● Suppose following relationships hold: ○ C = 10 + 0.9YD ○ T = 0.2Y ○ I = 25 ○ G = 17 ○ X = 24 ○ M = 0.1Y ● 1. Calculate the AE schedule ○ Rewrite the consumption function as a function of Y ■ C = 10 + 0.9YD ■ C = 10 + 0.9 (Y-T) ■ C = 10 + 0.9 (Y - 0.2Y) ■ C = 10 + 0.72Y ○ AE = C + I + G + X - M ■ AE = (10 + 0.72Y) + 25 + 17 + 24 - 0.1Y ■ AE = 76 + 0.62Y ● 2. Calculate the equilibrium level of national income? ○ In equilibrium AE = Y* ■ 76 + 0.62Y* = Y* ■ Y* = 200 ● 3. Graph the AE schedule. Clearly label the axes, the equilibrium level of national income, and any intercepts ● 4. All else equal, suppose government spending increases to 26.5 (from 17) . Use the multiplier to calculate the new equilibrium level of national income. ○ Since the slope of the AE function is 0.62, and thus the multiplier is: ■ 1/(1- Slope AE) = 2.63 ○ Thus, as the increase in autonomous government expenditure cycles through the economy, it causes subsequent increase in induced
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