Chapter 7 Flashcards
Describe the role of G
- Purchases of goods and services (G) à it is adding directly to the demand for the economy’s current output of goods and services.
- Transfer payments - also affects desired AE but only through the effect these transfers have on household’s income.
- Only G is part of desired aggregate expenditures (not including transfer payments).
- Assume G is autonomous with respect Y.
Describe how we see net tax revenues
Net taxes (T) are total tax revenues net of transfer payments.
We assume net taxes are given by: T = t * Y
where t is the net tax rate.
* As Y rises, a tax system with given tax rates will yield more revenue
(net of transfers).
* Assume that the tax rate is an autonomous policy variable.
* With t we represent a complex tax and transfer structure
What is the budget balance?
its G minus T, dont forget T=Y*t
if G < T: a budget surplus-»The government uses the excess revenue to buy back
outstanding government debt.
if G > T: a budget deficit–»The government must borrow the excess of spending over
revenues. It does this by issuing additional government debt
(bonds or treasury bills).
Recall, how do we find Yd now?
Yd=Y-T
Formula for net exports
NX= X-mY
where m is the marginal propensity to import
Ceteris paribus, changes in domestic GDP lead to changes in net
exports:
* as Y rises, NX falls
* as Y falls, NX rises
The relationship between Y and NX is shown by the net export
function
What is held constant in net export function
The NX function is drawn holding
constant:
* foreign GDP
* domestic and foreign prices
* the exchange rate
What shifts the net export function
- An increase in foreign income leads to more foreign demand for
Canadian goods:
* increases X and shifts NX function upward - A rise in Canadian prices (holding foreign prices constant):
* decreases X
* IM function rotates up as Canadians switch toward
foreign goods
è NX function shifts down and gets steeper
Write the expanded AE function and all its variables now
We then expand the AE function:
AE = C + I + G + NX
* Consumption: C = a + b * YD
* Investment: I
* Autonomous Government purchases G
* Net Tax Revenues T = t * Y
* Autonomous Exports X
* Imports IM = m * Y
Divide the AE function in autonomous and induced expenditure
Desired consumption: C = a + b (1-t) * Y (note: YD=(1-t)Y)
Now we sum the four components of desired aggregate expenditure:
AE = a + b (1- t) Y + I + G + (X – m Y)
AE = [a + I + G + X] + [b(1-t) -m] Y
auto induced
What is the MPS with these new inputs
z = b(1 - t) – m = MPC(1 – t) – m
Write the equilibrium betweem national savings and asset formation
S + (T – G) = I + ( X- IM)
What are the effects of taxes and imports on z and the intuition behind it
they make z smaller
z = MPC(1 – t) – m
Money that goes either to imports or taxes reduces the marginal propensity to spend out of national income, reducing the value of the simple multiplier
What is a stabilization policy
attempt to bring Y and Y* closer when there is a gap, it is done through fiscal policy, which is either intervention through the tax rate or through G
Explain the expected effects of fiscal policy
- Reduction in t or increase in G –» AE curve upward –» multiplier in motion –» increase equilibrium national income
- Increase in t or decrease in G –»AE curve downward –» decrease
equilibrium national income
Difference between use of g and t
t steepens or flattens while g is simply a shift, so g times simple multiplier will be the change
