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ECON 110 (192)
Chapter 22

Chapter 22.docx

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Queen's University
ECON 110
Ian James Cromb

Chapter 22: Adding Government and Trade to the Macro Model Introducing Government  Fiscal Policy is the use of the gov’ts tax and spending policies to achieve gov’t objectives Government Purchases  Purchases such as buying office supplies, purchasing fuel for the Canadian Forces, and hiring bureaucrats add directly to the demands for the economy’s current output o These desired gov’t purchases are part of aggregate desired purchases  Transfer Payments don’t affect desired aggregate expenditure – not directly, that is o Gov’t programs that transfer money to citizens (welfare) will affect desired AE because the citizens will affect demand as they choose to buy things Net Tax Revenue  Taxes reduce disposable income relative to national income – bigger number  Transfer payments raise disposable income relative to national income – smaller number  Net taxes are the total tax revenue minus transfer payments  should be positive number  We assume that the tax rate is an autonomous policy variable o As people earn more income, they pay more total taxes, but tax rate is unchanged  Net tax rate is the increase in net tax revenue generated when national income rises by $1 o Also called the marginal propensity to tax The Budget Balance  Budget Balance is the difference between total gov’t revenue and total gov’t expenditure  Budget surplus is when net revenues exceed purchases When the two are equal, the gov’t  Budget deficit is when purchases exceed net revenues has a balanced budget o When in deficit, it must borrow the excess by issuing gov’t bonds or treasury bills o When in surplus, gov’t buys back these bonds and treasury bills Provincial and Municipal Government  When measuring the overall contribution of gov’t to desired AE, all lvls must be included Introducing Foreign Trade Net Exports  Exports depend on decisions made by foreign bodies - exports = autonomous expenditure  Imports depend on the spending decisions of households and firms o As consumption rises, imports will also increase  it rises with national income o Imports = marginal propensity to import x national income  The MPI is the amount that desired imports rise when national income increases by $1  Net Exports = Exports – (the marginal propensity to import x national income)  Net exports are negatively related to national income  called the export function Shifts in the Export Function  It is drawn under the assumption that everything affecting net exports, except domestic national income, remains constant o The two major ones that must be held constant are foreign national income and international relative prices  a change in either will shift the function  Anything affecting Canadian exports will shift the function up or down o Up if exports increase; down if exports decrease  Anything affecting the proportion of income that Canadian consumers want to spend on imports will change the slope of the net export function Changes in Foreign Income  An increase in foreign income will lead to an increase in Canadian exports  This change causes the X curve to shift upward and therefore the NX function as well o The opposite is true for a decrease in foreign income Changes in International Relative Prices  If Canadian prices rise relative to foreign prices, imports will rise and exports will fall o The X curve shifts down and therefore the NX functions shifts down o Because imports are rising, the NX function has a steeper slope (rotate upward)  A fall in Canadian prices relative to foreign prices will have an opposite affect  Most important cause of change in international prices is a change in the exchange rate o A depreciation of the CAN$ means foreigners can pay less of their money to buy $1CAN and Canadian residents must pay more for foreign currency o Means that Canadian goods are cheaper for foreigners, and foreign goods are more expensive  exports rise, imports fall: function goes up, slope rotates down Equilibrium National Income Desired National Income  Take several steps to determine the relationship between consumption and national income in the presence of taxes  With taxes, the MPC out of national income is < the MPC out of
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