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Macroeconomics I
Fiscal policy in a closed and open economy
Mar, 28th, 2017
Problem 1 (BS/WS) – The government undertakes expenditure on goods and services of $100 million
and makes transfer payments amounting to 10 per cent of national income. The rate of direct taxation
is 30 per cent.
a)
b)
c)
d)
Draw a diagram showing autonomous government expenditure and net taxes as functions of
national income.
At what level of income does the government have a balanced budget?
Within what range of income does the government run a budget deficit?
Within what range of income does the government run a budget surplus?
Problem 2 (BS) – Investment is 450, consumption comprises 80 per cent of disposable income.
Government spending is 250 and net direct tax rate 10 per cent of income.
a)
Calculate the initial equilibrium income.
b)
Calculate the consumption expenditure, tax revenue and the government budget
deficit/surplus.
Suppose now that government expenditure increased by 500 and the tax rate was raised from 10 to 25
per cent.
c)
d)
e)
f)
g)
Before output has had time to adjust, by how much disposable income fell?
Calculate the resulting change in consumption expenditure and the net effect on aggregate
demand, remembering the increase in government expenditure.
What is the new equilibrium income level for the economy?
What is the government budget deficit/surplus?
Calculate the balanced budget multiplier.
Problem 3 (BS/WB) – An economy exports $150 million worth of goods each period. Imports always
comprise 20 per cent of income.
a) Draw a diagram which show imports and exports against national income.
b) At what level of income are imports equal to exports?
c) Within what range of income is there a surplus in trade balance?
Problem 4 – We consider an open economy with a state. Autonomous consumption is 70, marginal
propensity to consume is 0.8, net direct tax rate is 25%, investment expenditure is 120, government
expenditure is 150, exports are 60 and imports always comprise 10 per cent of income.
a)
b)
c)
d)
What is the equilibrium income?
Does the government run a budget deficit or surplus?
What about the trade balance?
How would the situation (income, budget and trade balance) change, if the marginal propensity to
import increased to 0.2?
e) How would the situation (income, budget and trade balance) change, if the marginal propensity to
import increased to 0.2 and exports increased by 100?
f) How should the government change the tax rate in order to balance the budget? How would the
equilibrium income and trade balance change then?
Adam Czerniak, Ph.D.
Department of Economics II
True/False
1. For a closed economy with a government to be in equilibrium, the following condition must be
satisfied: G + I = S + NT.
2. If autonomous spending increases, the aggregate demand function becomes steeper.
3. If the government increases taxes by $4 billion and increases spending by $4 billion, equilibrium
output increases by $4 billion.
4. A tax cut of $12 billion will have less effect on the economy than an increase in government
purchases of $12 billion.
5. The amount the government owes to the public is the deficit.
6. If tax receipts are less than government expenditures the government is running a deficit.
7. If the government runs a deficit, then the government debt increases.
8. During recessions, automatic stabilizers work to reduce government expenditures and increase
government revenues.
Multiple Choice
1. Fiscal policy refers to
a) the techniques used by a business firm to reduce its tax liability.
b) the behavior of the nationʹs central bank, regarding the nationʹs money supply.
c) the spending and taxing policies used by the government to influence the economy.
d) the governmentʹs ability to regulate a firmʹs behavior in the financial markets.
2. Which of the following is NOT a category of fiscal policy?
a) government policies regarding the purchase of goods and services.
b) government policies regarding taxation.
c) government policies regarding money supply in the economy.
d) government policies regarding transfer payments and welfare benefits.
3. What determines tax revenues?
a) the income tax rate.
b) current output in the economy.
c) the money supply in the economy.
d) the rate of inflation.
4. Disposable income:
a) increases when net taxes increase.
b) increases when income increases.
c) decreases when saving increases.
d) increases when saving decreases.
5. The government purchases multiplier is:
a) the difference between the old and the new equilibrium level of output.
b) the ratio of the change in government purchases to the change in the equilibrium level of output.
c) the ratio of the change in the equilibrium level of output to a change in government purchases.
d) the difference between the new and old levels of government purchases.
6. Which of the following is a CORRECT sequence of events during a recession?
a) unemployment falls, income falls, tax revenue falls, unemployment benefits rise, and the budget
deficit rises.
b) unemployment rises, income falls, tax revenue falls, unemployment benefits rise, and the budget
deficit rises.
c) unemployment rises, income falls, tax revenue rises, unemployment benefits fall, and the budget
deficit falls.
d) unemployment rises, income rises, tax revenue rises, unemployment benefits rise, and the budget
deficit rises.
Adam Czerniak, Ph.D.
Department of Economics II