L6 - Aggregate Expenditure and The Multiplier

Question 1

What is needed to use the Equilibrium Income model/diagram? (CAUSING SHIFTS)

Answer 1

Needs to be disturbed from its equilibrium by an exogenous (outside economy/not affected by income) shock

SHOCK DISPLAYED IN NOTES

Question 2

What is the Multiplier Effect?

Answer 2

Denoted by: K= 1/(1-b)

Where a fall in investment has a magnified impact of the fall in output.

Slopes of the AE lines just the MPC.

SHOWN IN DIAGRAM

Question 3

What does the Government sector consist of?

Answer 3

Consists of…
- Exogenous govt spending (G)
- Endogenous tax revenues
(T)

Addition of Govt sector means can now consider role of fiscal policy

Question 4

What is G assumed to be given by?

Answer 4

Exogenously given by the need to fund public services such as defence the police etc. which are essentially political rather than economic decisions

Question 5

What are Net Tax Revenues defined?

Answer 5

Tax revenues less transfer payments made. Since tax revenues always exceed transfer payments net taxes, or taxes, are always positive

Question 6

What is the Tax Function?

Answer 6

T= t0 + tY

Where:
t= MPT
t0= Autonomous Tax (Not related to income)

So,
Govt budget deficit: G-T= G-t0+tY

Govt Surplus: T-G= t0+tY-G

DIAGRAM ON NOTES

Question 7

What can Fiscal Policy defined as?

Answer 7

Defined as the DISCRETIONARY use of changes in G or T to affect the level of output.

DISCRETIONARY important because budget itself only partly exogenous

Question 8

What is Consumption with Govt sector added denoted as?

Answer 8

C=a+b(Y-T)

Question 9

What is Tax Revenue denoted as?

Answer 9

T=t0 + tY

EFFECT OF INCOME TAX RAISE

Question 10

What is Equilibrium Income by substituting Tax Revenue?

Answer 10

Y= (a-bt0)+b(1-t)Y+I+G

Y=(a-bt0+I+G)/(1-b(1-t))

Question 11

What is the Multiplier including Govt Spending?

Answer 11

Kg=1/(1-b(1-t))

Question 12

What is Keynes advice on Fiscal Policy?

Answer 12

recommended increases in G when the economy was stuck in a recession

As the budget deficit (G - T) gets larger aggregate expenditure increases, which boosts output and employment

Question 13

What are the Limitations of Fiscal Policy?

Answer 13

 Time lags: inside lags (recognition lag +decision lag) and the outside lag – means swift policy changes are rarely possible

 Forecasting accuracy is important, but impossible

 Public investment is irreversible – once you have started to build a hospital it makes no sense not to finish it!

 Financing issues: if the budget deficit is already large – as in 2008 – is it sensible to increase it further? Depends on size of country and financing history

Question 14

What are some statistics about European Economies budgets?

Answer 14

2013:
UK budget deficit 6%
Greece 12%
Slovenia 14%
Germany Budget Balance

Question 15

ALL OTHER GRAPHS ON NOTES

Answer 15

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