3. The following equations represent the aggregate behavior of aggregate demand in economy X:
C=1000+0.8 
I=200
G=1000
In addition, there is a flat tax rate of 15% over all income earned by households.
a) Determine the equilibrium output in this economy and represent the equilibrium on a graph.
b) Determine the budget deficit (or surplus) when the economy is in equilibrium.
c) Suppose that the government wants to balance its budget (that is, attain a deficit equal to zero, such that G=tY. Two alternative (and mutually exclusive) policies are considered: change government spending or change the flat tax rate.
i) Determine the new level of government spending that balances the budget under the first policy.
ii) Determine the new flat tax rate that balances the budget under the second policy.
iii) All else constant, what would be the best policy for the economy? Is there any simplification in the model presented in this question that might affect this conclusion? Explain.
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Related questions
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 |
