chap 7

• In our macro​ model, government purchases​ (G) is autonomous with respect to national income.
• G does not include government transfer payments. Net tax revenue​ (T) is total tax revenue collected by all governments, minus total transfer payments.
• The net tax​ rate, t, indicates the increase in tax revenues generated when national income increases by $1
• T enters the AE function only indirectly through its effect on disposable income in the consumption function.
• If G is larger than​ T, there is a budget deficit.

  If G is smaller than​ T, there is a budget surplus.

  The budget is in balance when G=T.
• transfer or purchases

  • Welfare payments for the poor = Transfers
  • Payments to teachers in public schools = Purchases
  • Payments to teachers at a military college = Purchases
  • Payments to hospitals and physicians = Purchases
  • Public vaccination programs = Purchases
  • Old Age Security payments to the elderly = Transfers
• what is the role of government in the aggregate expenditure​ model?

  A.All levels of government must be included when measuring its contribution to desired aggregate expenditures.

  B.When government has a budget deficit comma the budget balance will be positive.

  C.The budget balance will increase if government spending increases.

  D.Private saving is always smaller than budget balance.

  E.Transfer payments directly affect aggregate expenditures.

  
  

  Correct answer is A
• Consider the​ government's budget balance. Suppose G=570 and the​ government's net tax revenue is 10 percent of Y. The government budget is balanced when Y equals​ 5700.
• In our macro​ model, exports​ (X) are autonomous with respect to domestic national​ income, but the X function will shift in response to changes in foreign income and international relative prices.
• The marginal propensity to import​ (m) indicates the increase in desired imports when national income rises by $1.
• The equation for the net export function​ (NX) is NX=X−mY. As national income​ rises, imports rise​; NX is therefore negatively related to national income.
• If Canadian prices rise relative to those in other​ countries, then imports will rise and the net export function will shift downward. If Canadian prices fall relative to those in other​ countries, imports will fall and the net export function will shift upward.
• With the addition of government and foreign trade to the simple macro​ model, the marginal propensity to spend out of national income is less than the marginal propensity to consume out of disposable income.
• Consider the following​ equation: z=​MPC(1−​t)−m.

  The term t represents net tax rate.

  The term m represents marginal propensity to import.

  The term z represents marginal propensity to spend on domestic output
• If there is no government and no foreign​ trade, the simple multiplier can be written as $1/(1-z)$​, where z=MPC.

  With government and foreign​ trade, $z=$$MPC(1-t)-m$.
• In comparison to a model with no government and foreign​ trade, once we add taxes and​ imports, the value of the simple multiplier is lower.

  As a​ result, the effect on equilibrium national income of a change in autonomous expenditure will be smaller in the presence of taxes and imports.
• Our simple macro model has made an important assumption that the price level is constant. We say that​ output, or national​ income, is demand determined.
• The assumption that the price level is

  constant implies that firms are willing and able to produce any amount of output that is demanded without requiring any changes in prices. In this​ case, national income depends only on how much is demanded. We are not yet considering supply​-side influences on national income.
• Suppose national income is less than its equilibrium amount​ (for example, think of unintended changes in inventories so that t aI≠Ia​).

  That​ is, desired national income is more than the actual one.​ 

  Hence, the desired consumption is more than the actual one.

  Some of the desired expenditure must either be frustrated or take the form of purchases of inventories of goods that were produced in the past.

  As firms see their inventories being​ depleted, they will increase ​production, thereby increasing the level of national income .
• The economy of Stranglethorn has the following​ parameters:

  Autonomous desired consumption expenditures are ​$400.

  Marginal propensity to consume out of disposable income is 0.70

  Net tax rate of national income is​ 10%.

  Autonomous desired investment expenditures are ​$250

  Autonomous government purchases are ​$350

  Autonomous export expenditures are ​$50.

  Marginal propensity to import is 0.10

  The level of desired autonomous aggregate expenditures in this economy is ​$1050
• The economy of Stranglethorn has the following​ features:

  Autonomous desired consumption expenditures are ​$400

  Marginal propensity to consume out of disposable income is 0.80

  Net tax rate of national income is​ 10%.

  Autonomous desired investment expenditures are ​$200

  Autonomous government purchases are ​$400

  Autonomous export expenditures are ​$400

  Marginal propensity to import is 0.20

  The desired aggregate expenditure function in Stranglethorn can be written​ as:

  AE=1400+0. 52 * Y
• AE = 1400 + 0.52Y

  Using the function​ above, compute the equilibrium level of expenditures in Stranglethorn.​ Y=$2,917
• Suppose that the economy of Stormwind has the following​ features:

  The level of private saving is ​$200.

  The level of investment expenditure is ​$100.

  The level of exports is ​$50.

  The level of imports is ​$100.

  Equilibrium, the level of public saving would be equal to ​$-150. ​

  The level of public saving shows that the government in Stormwind has a budget deficit

  If the level of government purchases is ​$200 in Stormwind, the level of taxes must be ​$50. ​
• Consider an aggregate consumption function in a simple macro model with government and taxes. Given a marginal propensity to consume out of disposable income of 0.88 and a net tax rate of 9 percent of national​ income, the marginal propensity to consume out of national income is 0.80
• Consider a simple macro model with a constant price level and​ demand-determined output. The equations of the model​ are: C=100+0.75Y​, I=400​, G=500​, T=0, X=120​, IM=0.09Y.

  The marginal propensity to spend on national​ income, z​, is​ 0.660.
• Consider a simple macro model with a constant price level and​ demand-determined output. The equations of the model​ are: C=60+0.38Y​, I=120​, G=290​, T=​0, X=125, IM=0.08Y.

  A national income of 1000 results in desired aggregate expenditure of​ 895
• Consider a model in which output is​ demand-determined. If the marginal propensity to spend out of national income is 0.55​, then a ​$0.7 billion increase in government purchases will cause equilibrium national income to increase by approximately 1.56.
• In the aggregate expenditure​ model, the assumption of a constant price level implies that

  A.national income is fixed.

  B.the level of consumption expenditures is fixed.

  C.firms are able and willing to produce any amount of output that is demanded without requiring price changes.

  D.the level of exports will only change if foreign income changes.

  E.the multiplier is the same whether we have a closed or open economy.

  
  

  Correct answer is C.firms are able and willing to produce any amount of output that is demanded without requiring price changes.
• We can expect the national income to be​ demand-determined when

  A.the actual level of unemployment is equal to the natural level of unemployment.

  B.firms have excess capacity.

  C.the economy is at its full employment level.

  D.the economy is experiencing an inflationary gap.

  E.the cyclical unemployment is negative.

  Correct answer is B.firms have excess capacity.