question archive Consider a closed economy (no foreign trade or NE = 0) described by the following equations (all figures in millions of dollars): Y = C + I + G Further assume: Annual government expenditure equals $2,000
Consider a closed economy (no foreign trade or NE = 0) described by the following equations (all figures in millions of dollars): Y = C + I + G Further assume: Annual government expenditure equals $2,000
Subject:EconomicsPrice:8.89 Bought3
Consider a closed economy (no foreign trade or NE = 0) described by the following equations (all figures in millions of dollars): Y = C + I + G
Further assume:
Annual government expenditure equals $2,000.00
Current level of income tax is combination of flat Tax and income adjusted, based on following tax rate; Tax = 1,000 + .25(Y) where Y is the level of current income for the economy.
Current annualized consumer spending equals: C = 450 + 0.8 (DI), were
DI = Disposable income = Income - Tax
Current level of short-term investment is fixed and equals to $2,000.00
a) Calculate the current value of Y for this economy at the equilibrium level.
b) Based on that income, calculate the current state of private saving, public saving and current level of tax intake. What do the information you calculated tell you about the current state of this economy?
c) Suppose the congress approve an infrastructure investment which raises government expenditure to 2,250. How would this increase impact your calculation in (a) above if government barrows the money verses raising tax to cover it?
d) Now suppose the business community is optimistic about the future of economy and decide to increase the level of investment by 10%, how would the change in investment impact the economy (in term of consumption, saving, taxes, etc.)? Compare the result you get in (c) with what you calculated in (a). What does it tell you?
e) Now suppose based on the data, you know you have a GDP gap of $875 million (gap in the value of GDP which is the same as income gap in term of Y), what would be the necessary injection you would need to close this gap? Which component of the GDP would you use and why?
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PART A
Y = C + I + G
Y = 450 + 0.8 (DI) + $2,000.00 + $2,000.00
Y= $4,450 + 0.8 (DI)
Replace DI
Y= $4,450 + 0.8 (Y -Tax)
Y= $4,450 + 0.8*( Y - 1,000 -0. 25Y )
Y= $4,450 + 0.8*( 0.75Y - 1,000 )
Y= $4,450 +0.6Y -800
Y = 0.6Y +$3650
Y - 0.6Y = 3650
0.4Y = 3650
Y = 3650/0.4 = $ 9125
PART B
Y= $ 9125
C= Y -I -G = $ 9125 - $ 2000 - $ 2000 = $ 5125
Tax = 1,000 + 0.25(Y) = 1000 +0.25*9125 = $ 3,281.25
Private saving = Y-T -C = $9125 -$ 3,281.25- $ 5125 = $ 718.75
Public saving = T - G =$ 3,281.25- 2000 = $ 1,281.25
Current level of investment is $2000 in the economy; however, public saving is positive indicating government expenditure is less than government revenue through tax. Government has budget surplus in this current situation.
PART C
As G increases from $ 2000 to $2250, budget surplus increases in the short run. However, it raises total output of the economy
Y = $ 5125+ 2000+ 2250 = $9375
If government borrows money instead of raising tax now, it must have to tax in future to pay out the debt in future. Therefore, public debt at current year will create tax burden for future generations.
PART D
If investment increases by 10% ; New I = 2000(1+.10) = $2200
Y = $ 5125 + $2200 + $2000 = $ 9325
Tax = 1,000 + .25(Y) = 1,000 + .25*9325 = $3,331.25
C = $ 9325 - 2200 -2000 = $5125
Private saving = Y-T -C = 9325 - 3,331.25- 5125= $ 868.75
Public saving = T-G = $3,331.25- 2000 = $1,331.25
PART E
If Y = $875
Deficit = $ 9125 - $875 = $ 8,250
Injection needed to close this gap = $ 8,250
Increase the government annual government expenditure to bridge the gap since the government can borrow to support the economy
