22.1 Introducing Government
Fiscal policy: the use of the government’s tax and spending policies to
achieve government objectives.
o It influences national income in both the short and the long run.
When a government makes purchases, it is adding directly to the demands
for the economy’s current output of goods/services.
Government transfer payments affect AE only through the effect these
transfers have on households’ disposable income.
Assumption is made that the level of government purchases, G, is
autonomous with respect to the level of national income.
Net taxes: total tax revenue minus transfer payments, denoted T.
Where t is the net tax rate.
o Net tax rate: the increase in net tax revenue generated when national
income rises by one dollar. Also called the marginal propensity to tax.
Budget balance: the difference between total government revenue and total
Budget surplus: any excess of current revenue over current expenditure.
o The surplus is used to purchase back existing government debt.
Budget deficit: any shortfall of current revenue below current expenditure.
o In this case, government’s have to borrow the excess spending by
issuing additional government debt (bonds/treasury bills).
The federal government raises about the same amount of tax revenue as do
the provincial and municipal governments combined but transfers a
considerable amount of its revenue to the provinces.
When measuring the overall contribution of government to desired
aggregate expenditure, all levels of government must be included.
**Recall** YD= Y – T
22.2 Introducing Foreign Trade
Canada exports roughly 3% of all the goods/services produced in it.
U.S.-Canadian trade is the largest two-way flow of trade between any two
countries in the world today.
Typically, exports will not change as a result of changes in Canadian national
o Thus treated as autonomous expenditure.
Imports depend on the spending decisions of Canadian households and firms.
o Almost all consumption goods have an import content. o Since consumption rises with national income, imports will rise with
national income as well.
Where m is the marginal propensity to import.
o Marginal propensity to import: the increase in import expenditures
induced by a $1 increase in national income. Denoted by m.
In our simple model,
The above function is called the net export function.
o Net exports are negatively related to national income.
Anything affecting Canadian exports will shift the net export function parallel
o Up if exports increase (vice-versa).
Anything affecting the proportion of income that Canadian consumers want
to spend on imports will change the slope of the net export function.
A change in foreign income will affect both the X curve as well as the NX
o An increase in foreign income will increase demand for Canadian
A shift up in X and a shift up in NX.
o A decrease in foreign income will decrease demand for Canadian
A shift down in X and a shift down in NX.
A change in international relative prices will cause both imports and exports
to change (in turn, will shift the NX function).
o A rise in Canadian prices relative to those in other countries will:
Increase demand for imports in Canada and reduce demand for
Canadian products abroad.
X function will shift down; IM curve will rotate up.
IM curve will rotate up because Canadian will spend a
higher fraction of national income on imports.
o A fall in Canadian prices relative to those in other countries will:
Decrease demand for imports in Canada and increase demand
for Canadian products abroad.
X function will shift up; IM curve will rotate down.
A depreciation in the Canadian dollar means that less of a foreign currency is
needed to purchase $1 Canadian and $1 Canadian will purchase less of a
o This will result in less i