Chapter 22 Flashcards
purchases of goods and services by the government (G) does what for the economy?
it is adding directly to the demand for the economys current output of goods and services.
how do transfer payments affect the economy
affects desired AE but only through the effect these transfers have on households income (indirectly through impacting income)
what is part of desired aggregate expenditures (not including transfer payments)?
only G
G is autonomous with respect to what
Y
def. net taxes (T)
total tax revenues net of transfer payments
**assume given by T= t*Y
where t is the net tax rate
describe the characteristics of net taxes formula
- 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
def. budget balance
difference between G and T (ignoring debt-service payments)
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).
when measuring the overall contribution of government to desired aggregate expenditure, do all levels of government need to be included?
- yes
- particularly important in Canada
- combined purchases of provincial and municipal governments are large than those of the federal government
What are the 4 key things to remember when thinking about government and taxes?
- All levels of government add directly to desired AE through their
purchases of goods and services (G). - G will be treated as an autonomous expenditure in our model.
- Net tax revenues (T) is positively related to Y.
- T will enter the AE function indirectly, through its effect on disposable income (YD). Recall: YD = Y - T.
What are the two central assumptions we make when considering net exports?
- Canada’s exports are autonomous with respect to Canadian GDP
- Canada’s imports rise as Canadian GDP rises
What is the formula for imports?
IM=mY
*where m is the marginal propensity to import
net export formula
NX= X - mY
- *changes in domestic GDP lead to changes in net exports:
- -as Y rises, NX falls
- -as Y falls, NX rises
what is held constant when drawing the NX function?
- foreign GDP
- domestic and foreign prices
- the exchange rate
Describe the two main reasons for shifts in the net export function and what they cause
- 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
- ->NX function shits down and gets steeper
what is the expanded AE function?
AE= [a + I + G + X] + {b(1-t) - m]Y
What is the marginal propensity to spend with taxes and trade?
z=b(1-t)-m
z= MPC (1-t)-m
**is the slope of the AE function
What is the equilibrium condition?
equilibrium Y occurs where desired aggregate expenditure equals actual national income
What is the Saving-Investment approach to equilibrium in an open economy with government?
National Savings = National Asset Formation
S+(T-G)= I + (X- M)
What is the Saving-Investment approach in equilibrium with wealth?
Y-AE= W
describe intuition with the simple multiplier with taxes and imports
The presence of imports and taxes reduces the marginal
propensity to spend out of national income and thus reduces the value
of the simple multiplier
- the higher the m, the lower the simple multiplier
- the higher the t, the lower the simple multiplier
What is the simple multiplier with gov and foreign trade?
1/ (1-[MPC(1-t)-m])
def, fiscal policy
the use of the government’s spending (G) and tax policies (t) w
**Goal: stabilization policy
def. stabilization policy
any policy that attempts to stabilize Y at or near Y*
**often clear in which direction fiscal policy should be adjusted, less clear how much is necessary
Expected effects of fiscal policy:
- A change in G –> shifts AE–> multiplier in motion–>changes equilibrium Y
- a change in t –> changes the slope of AE—> changes in equilibrium Y
What are the different effects of changing the net tax rate?
- a lower t causes the AE function to become steeper
2. a higher t causes the AE function to become flatter
when is the assumption of a constant price level reasonable?
- When output is below potential, firms can increase output without increasing their costs.
- When firms are price setters they often respond to shocks by changing output (and only later changing their price).
