Fiscal Policy

1. Suppose the economy is in recession. The government decides to run a deficit to fund a jobs program. Find equilibrium GDP using the following data:
C = 50 + .7(Y – T)

I = 40

G = 35

T = 20

Xn = -10

2. Now suppose a Balanced Budget Amendment to the Constitution was passed, requiring the government to balance its budget. As a result, government spending is cut in order to balance the budget. Calculate the new level of GDP. Check your answer by using the multiplier method (multiplier x change in spending). What effect will balancing the budget have on GDP and on the recession?

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Parrain Parrain · Answer 1 · 2022-04-19T16:06:14+02:00

Based on the economic data given, and the fact that the government is running a deficit, the equilibrium GDP will be 336.67.

If government spending is cut to balance the budget, the new level of GDP will be 321.67.

The effect of balancing the budget will be a decrease in GDP and a slower recovery from the recesssion.

This is given by the variable "Y" so we can find the equilibrium GDP by solving for it:
C = 50 + .7(Y – T)

Y = C + I + G - XN

C = Y - I - G + XN

Solving gives:

Y - I - G + XN = 50 + .7(Y – T)

Y - 40 - 35 + 10 = 50 + 0.7Y - 14

Y - 0.7Y = 50 + 40 + 35 - 10 - 14

0.3Y = 101

Y = 101/0.3

= 336.67

Government spending will have to be cut to a size that would make it equal to taxes so government spending becomes 20.

New GDP becomes:

= C + I + G - XN

= ( 50 + .7(Y – T)) + 40 + 20 - 10

= 271.67 + 40 + 20 - 10

= 321.67

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