a.What is the short-run equilibrium output for FarFarAway? Please show your calculation.
b.Briefly explain how the government of FarFarAway can change from the short-run equilibrium output (i.e. your answer to (a)) to the potential output using fiscal policy. In your answer, please state only one tool that the government can use to implement this policy and explain how it can affect output.
Answer
The short run equilibrium output is the output level at which Y = AE, which AE is the sum of consumption (C), private investment ( I ), government expenditure (G) and Net export (NX).
The equation Y = 1000+0.8(Y-T) + 2000-1000r +2000 + 90 will be obtained. Given in the question, the income taxes is T = tY. This can be substituted into the consumption function.
The equation is as follow:
Y = 1000+0.8(Y-T) + (2000-1000r) +2000 + 90
Y = 5090 + 0.8(Y-tY) -1000r
Y = 5090 + 0.8(Y-tY) -1000(0.05)
Y = 5040 + 0.8(Y-0.2Y)
Y = 5040 + 0.64 Y
Y = 14000
Therefore, the short run equilibrium output is 14000.
b. We can change from the short-run equilibrium output 14000 to the potential output 15000 using expansionary fiscal policy, which aims at increasing the short-run equilibrium output.
The Essay on Short Story Run Doesn Night Road
He doesn't sleep for more than a few hours. He doesn't know why it is, just that he has never been able to let the night take him. The house isn't big enough to hold his thoughts. Everyday it's on his mind. The pain only comes when he tries to rest. He tries filling his time with activities to make himself better. Three a. m. is when he starts running. It's the best time to go for a run, no one to ...
There are two tools that the government can use. The first one is to increase the government expenditure. The second one is to decrease taxes. Refer to the question, only one tool that the government can use to implement this policy. So to increase government expenditure should be used.
The increase in government expenditure can lead to an increase in aggregate demand such that the aggregate demand curve shifts to the right. At this new equilibrium, both the equilibrium price level and the equilibrium output increase. Therefore, increasing the government expenditure can achieve potential output.
Suppose the government increases spending by 100, that is from 2000 to 2100, on education such that the new value of G = 2100. At Equilibrium,
AE = Y,
Y= 5140 + 0.64Y
Y= 14277.78
So the equilibrium output Y = 14278. But the change in equilibrium output is equal to (14278-14000) = 278, which is much larger than the increase in the actual government spending 100.
This process includes two steps. At first, the government expenditure increases by 100 and the equilibrium output also goes up by 100. But then, the consumption goes up by 64 with the increase in 100 of the equilibrium output. Therefore, we can conclude that the overall change in equilibrium depends on the size of the multiplier.
8.2The following table shows the planned expenditure of Country A at various levels of real GDP. This country’s potential real GDP is 220. The current personal income tax rate is 20 percent.
Real GDP,
YPrivate
consumption,
CPrivate
investment,
IGovernment spending,
G
Net export,
NXBudget deficit,
G minus T
50325040330
100645040-420
150965040-1110
2001285040-180
2501605040-25-10
a.If this country is currently at equilibrium, what is the value of its real GDP? What is the government’s budget deficit position? What is the value of the output gap? Briefly explain your answer.
c.Suppose the government of Country A in part (a) would like to eliminate the output gap, can you suggest one possible fiscal policy that can help the government of Country A to achieve its target? Briefly explain how your suggested policy can eliminate the output gap.
The Essay on Evaluate the case for cutting public expenditure rather
A fiscal deficit is when a government’s total expenditures exceed the tax revenues that it generates. A budget deficit can be cut by either reducing public expenditure or raising taxes. In this essay, I am going to analyse the benefits and costs of increasing tax rates to reduce fiscal deficits instead of cutting government expenditure. First of all, if the government decides to cut current ...
Real GDP,
YPrivate
consumption,
CPrivate
investment,
IGovernment spending,
G
Net export,
NXBudget deficit,
G minus TAggregate planned expenditure AE
(C+I+G+NX)
50325040330125
100645040-420150
150965040-1110175
2001285040-180200
2501605040-25-10225
Answer
a.The aggregate planned expenditure should be first calculated.
The value of the real GDP:
The planned expenditure should be equal to the actual expenditure whe Country A is at equilibrium. Refer to the table above, the aggregate expenditure is equal to the real GDP when it is 200. So in equilibrium, the value of real GDP should be 200.
The government’s budget deficit position:
The government’s deficit budget is 0 when the aggregate expenditure and the real GDP are both at 200. It means that the government expenditure is equal to the tax revenue. So the government actually has a balanced budget.
Value of output gap:
Output gap = Actual real GDP – Potential GDP
So the value of the output gap is
= 200-220
= -20
b.
To eliminate output gap, the government of country A should increase the government spending to achieve its target. GDP multiplier needs to be found to find out the value to be increased in terms of government spending.
GDP multiplier = Change in equilibrium real GDP/ Amount changed in AE = (250
– 200) / (225 – 200)
= 50 / 25
= 2
So the GDP multiplier is 2. The required change in government spending = the required change in equilibrium real GDP / GDP multiplier = 20 /2 = 10
Therefore the government in Country A should increase the government spending by 10 in order to eliminate the output gap.
