Economists in Macroland believe that the full employment GDP is 7,500, and they

Question

Economists in Macroland believe that the full employment GDP is 7,500, and they calculate the structural deficit at that level. In 2009, the economy was described as follows:

Y = C + I + G + (X – IM)

C = 100 + 0.8DI

DI = Y – T

T= 0.25Y

I = 800

G = 1700

(X – IM) = 0

a)     What was the equilibrium GDP in 2009?

b)     What was the multiplier?

c)     What was the government’s surplus or deficit?

d)     What was the structural surplus or deficit?

e)     The government decided to move the economy to full employment in 2010, a year in which the above structure of the economy did not change, except for G. What change in G was necessary?

f)      What was the government’s surplus or deficit in 2010?

g)     Does a comparison of the government’s actual surpluses or deficits in 2009 and 2010 give a good indication of the change in fiscal policy? Why or why not?

h)     Compare the structural deficits in the two years. What does this comparison tell you about fiscal policy?

i)      Use a diagram like in the text to show what has happened to GDP, the actual deficit, and the structural deficit.

Explanation / Answer

a) Y = C + I + G + (X – IM)

C = 100 + 0.8DI

DI = Y – T

T= 0.25Y

I = 800

G = 1700

(X – IM) = 0

Y = 100+0.8 (Y-0.25Y) + 800+1700

Y = 2600+0.6Y

0.4Y = 2600

Y = 2600/0.4 = 6500crores.

b) Multiplier = 1/1-b = 1/1-0.80 = 1/0.2 = 5

c) Government Expenditure = 1700 Government revenue = 0.25(6500) = 1625

Government budget is in deficit by 75 crores (1700-1625)

d) Structural deficit = 1000crores (full employment level -equilibrium level = 7500-6500)

e) If government wants to increase income at full employment level, then it needs to increase government expenditure by 200 crores.

K = change in income/ change in government expenditure

5 = 1000/change in government expenditure

change in government expenditure = 1000/5 = 200

f) In 2010 government budget was in deficit total expenditure = 2700, total taxes = 1625 deficit = 1075crores.

g) No, it is not a ood indication because increase in fiscal deficit o much may take economy into debt trap which may create finaical crisis in the economy.

h) There si no structural defcit in 2010 while in 2009 structural deficit was 1000 crores.

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