suppose European governments cut back their spending. Explain how this may have

Question

suppose European governments cut back their spending. Explain how this may have a differential impact on economic output depending on the openness of the economy and on the tax system. Differentiate between (A) on the one hand countries that have a relatively open economy and have a high income tax rate and (B) on the other hand countries that have a rather closed economy and have a low income tax rate. Use a formula to make your arguments clear. Also provide an explanation in words by using the correct economic terminology. Illustrate the aforementioned arguments by means of the Keynesian Cross.

First draw a separate graph (using the diagrams below) for each of the types of countries illustrating the situation prior to the reduction in government spending. Also provide a clear explanation regarding the way both diagrams may or may not differ between countries.

Second, assume that government spending is reduced by exactly the same amount in both types of countries. Use the diagram in to illustrate this impact. Also provide below some explanation in words why and how this reduction in government spending may or may not have a differential impact for both types of economies.

Explanation / Answer

Suppose European governments cut back their spending.

Explain how this may have a differential impact on economic output depending on the openness of the economy and on the tax system.

Governments try to maintain national income i.e. Gross Domestic Product at equilibrium level by employing fiscal policies. These policies are based on spending and taxing decisions which are used to influence the state of the economy in the country. Fiscal policy can be of two types- EXPANSIONARY or CONTRACTIONARY.

Situation given in the question occurs when the government chose to practice contractionary fiscal policies.

With regard to degree of openness of an economy, more it is integrated with the world and trade globally its fiscal policies will affect deficit levels. In case of more open economy net export will reduce and this will deplete the foreign exchange reserve of the country.

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.