To support the economy against a recession triggered by the Coronavirus, the government is considering increasing public spending. Suppose the government decides to finance the additional spending with new taxes, and to increase taxes by the same amount as public spending. A critic to the government objects saying that if public spending and taxes increase by the same amount, no increase in GDP should be expected: what the government gives to the economy is taken back via taxes. Use the model of aggregate demand and aggregate supply to study if the proposed economic policy could increase GDP by computing the fiscal multipliers. a) Start from the model C + I + G + NX = Y with C the aggregate level of
To support the economy against a recession triggered by the Coronavirus, the government is considering increasing public spending. Suppose the government decides to finance the additional spending with new taxes, and to increase taxes by the same amount as public spending. A critic to the government objects saying that if public spending and taxes increase by the same amount, no increase in GDP should be expected: what the government gives to the economy is taken back via taxes. Use the model of aggregate demand and aggregate supply to study if the proposed economic policy could increase GDP by computing the fiscal multipliers. a) Start from the model C + I + G + NX = Y with C the aggregate level of
Chapter24: Fiscal Policy
Section: Chapter Questions
Problem 5P
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Transcribed Image Text:To support the economy against a recession triggered by the Coronavirus, the
government is considering increasing public spending. Suppose the
government decides to finance the additional spending with new taxes, and to
increase taxes by the same amount as public spending. A critic to the
government objects saying that if public spending and taxes increase by the
same amount, no increase in GDP should be expected: what the government
gives to the economy is taken back via taxes.
Use the model of aggregate demand and aggregate supply to study if the
proposed economic policy could increase GDP by computing the fiscal
multipliers.
a) Start from the model C + 1 + G + NX = Y with C the aggregate level of
consumption, I the aggregate level of investment, G the level of fiscal
spending, NX the net experts and Y the level of GDP. Assume NX = 0
and assume that C = c0 + c1(Y-T), with T the level of taxes. Interpret
the economic intuition behind the function for consumption. What is
c1?
b) Derive the equilibrium level of GDP associated with this model. Study
by how much Y increases when G increases under the assumption T=G.
Does your model predict that Y will be affected by the government
intervention? Why?
c) Now assume that NX = X - mY, where X represents total exports and m
represents the marginal propensity to import. How does your answer to
question b) change? Why?
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