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PROBLEMS
1.
2.
The 1997 fiscal policy package included roughly $200 billion in government
spending cuts and $70 billion in tax cuts. If all the tax cuts were given to
households, by how much would aggregate demand shift (a) initially and (b)
ultimately as a result of the policy package?
a.
AD would initially decrease by $200 billion (due to the decrease in
government spending) but, at the same time, increase by some
percentage of the $70 billion in tax cuts. Given the tax cut, the
consumers will only increase their spending by the MPC x Taxes. If we
assume an MPC of 0.80, then consumption spending will increase by
$56 billion due to a $70 billion tax cut. The net impact is that AD will
initially decrease by $144 billion.
b.
The ultimate change in equilibrium GDP will depend on the value of the
MPC and the multipliers. Again assuming an MPC of 0.80 then the
multiplied changes in AD will be:
-200 billion x 5 = -1,000 billion
+56 billion x 5 = + 280 billion
___________
-$ 720 billion
Suppose the federal budget is balanced but that automatic stabilizers increase tax
revenues by $20 billion per year and decrease transfer payments (e.g., welfare,
unemployment benefits) by $8 billion per year for every 1-percentage point change in the
real GDP growth. Using this information, complete the following table:
Change in
GDP Growth Rate
-2%
+1%
+3%
3.
Change in
Tax Revenue
-$40 billion
+$20 billion
+$60 billion
Change in
Transfer Payments
+$16 billion
-$8 billion
-$24 billion
Change in
Budget Balance
-$24 billion
+$12 billion
+$36 billion
Based on the information in the preceding question, what will happen to the federal
budget balance if the economy falls into a recession of –2.0 percent from a growth path
of +2.5 percent?
If the economy falls into a recession of –2.0 percent, resulting in a budget
balance change of -$24 billion, from a growth path of +2.5 percent, resulting in
a budget balance change of +$30 billion, the net result would be a -$54 billion
change in the budget balance.
4.
The following table presents hypothetical data on government expenditure, taxes,
exports, imports, inflation, unemployment, and pollution for three levels of equilibrium
income (GDP). A government decision maker is trying to determine the optimal level of
government expenditures, with each of the three columns being a possible choice. At the
time of the choice the inflation index is 1.0. Dollar amounts are in billions per year.
(a)
(b)
(c)
(d)
(e)
(a)
Compute the federal budget balance, balance of trade, and real GDP for each
level of nominal GDP.
What government expenditure level would best accomplish each of the following
goals?
Lowest taxes collected, largest trade surplus, lowers pollution, lowest inflation
rate, lowest unemployment rate, highest amount of public goods and services,
highest real
Nominal GDP
$7,000 $8,000 $9,000 income, balancing
the federal budget,
Government expenditure $700
$800
$900
Taxes collected
$600
$800
$1,000 achieving a
balance of trade,
Exports
$300
$300
$300
maintaining price
Imports
$100
$300
$500
stability, achieving
Inflation (index)
1.00
1.04
1.15
full employment.
Unemployment rate
10%
4%
3.5%
What
Pollution index
1.00
1.80
2.00
government
expenditure levels would most flagrantly violate each of the preceding goals?
Which policy would be in the best interests of the country?
What policies, in addition to changes in government expenditures, might the
government use to attain more of its desired goals?
Completing the information from the table in the text:
Nominal GDP
7000
Federal Budget Balance
Balance of Trade
Real GDP
(b)
9000
0
0
7692
100
-200
7826
The level of expenditures that would best accomplishes each goal, and (c) the
level that would most flagrantly violate each goal.
BEST
EXPENDITURE
700
700
700
700
900
900
900
800
800
700
800
(d)
8000
-100
200
7000
GOAL TO BE ACCOMPLISHED
Lowest taxes
Largest trade surplus
Lowest pollution
Lowest inflation rate
Lowest unemployment rate
Most public goods and services
Highest Real Income
Balanced federal budget
Balancing balance of trade
Price stability
Full employment
WORST
EXPENDITURE
900
900
900
900
700
700
700
700,900
700,900
900
700
There is no clear best policy because there are competing macroeconomic goals.
(e)
Monetary policy and supply side policies, as well as changing taxes, might be
used in addition to changes in government spending in the attempt to attain more
desirable goals.