ECON MACRO
5th Edition
ISBN: 9781337430401
Author: William A. McEachern
Publisher: Cengage Limited
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Question
Chapter 11, Problem 1.2P
To determine
The recessionary Gap and the fiscal policies that would close the gap with the help of a graph.
Concept Introduction:
Recessionary Gap: Recessionary Gap is the gap between actual output and potential output under full employment situation, when actual output is less than potential output.
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6. Graphical treatment of taxes and fiscal policy
The main difference between variable taxes and fixed taxes is that unlike fixed taxes, variable taxes do not vary with GDP
The following graph shows the consumption schedule for an economy with a given level of taxes. Suppose the government implements a tax
increase through a fixed tax.
Use two green points (triangle symbol) to connect the two black points (plus symbols) representing the consumption schedule after the change in
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Hint: The new consumption schedule must pass through one point on the left and one point on the right.
Hint: The new consumption schedule must pass through one point on the left and one point on the right.
50
Consumption with Tax Increase through a Fixed Tax
Consumption with Tax Increase through a Variable Tax
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20
40
60
80
100
REAL GDP (Billions of dollars)
The blue line on the next graph represents the original total expenditure line for this economy before the change in tax structure.
Use the new…
(Use for a and b)Suppose the interest on the debt was $700 billion. If interest is paid domestically, 90% will be spent domestically (the remainder is spent on foreign goods). If interest is paid to the foreign sector, only 10% is spent here (the remainder is spent in foreign countries). Every dollar collected in taxes to pay the interest causes domestic spending to fall 90 cents. The spending multiplier is 2.
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b) What is the net impact on GDP if 20% of the interest is paid to the foreign sector?
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(Fiscal Policy) Chapter 11 shows that increased government purchases, with taxes held constant, can eliminate a recessionary gap. How could a tax cut achieve the same result?
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