ECS2602 October 2020 Macroeconomics 2602 Macroeconomics II - Popular Exam Q's MEMO

Macroeconomics II - Popular Exam Q's MEMO 1. Using the Goods Market model explain how a balanced budget can still lead to an increase in output and income. {OR] Using the Goods Market model explain how a simultaneous increase in government spending and increase in taxes can lead to an increase in output and income. A balanced budget still increases output. The difference between the initial impact of a change in government spending and a change in taxes implies that even if the change in G is equal to the change in T, 8G = 8T, it will still have an expansionary effect on the economy. By way of an example, assume that the increase in government spending is 100 (which is identical to that of the amount received in taxes) i.e. 8G = 8T = 100. And that the marginal propensity to consume (c or MPC) = 0.8. Applying the Goods Market model, the effect on income through government spending is given by 8Y=a8G where a = - 1 - and c being the marginal propensity to 1-c consume (found as the slope on the ZZ curve). Therefore a = - 1 - = 5 therefore 8Y=(5)(100) = 500 i.e. 8G=100 resulted in a 8Y=500 i.e. G is 1-0.8 autonomous and not influenced by c. Similarly the 8T=100 yields a decrease in 8Y= ac8T = (5)(0.8)(100) = 400. Note the effect of c. The net effect is 500 minus 400 = 100 i.e. a growth in output. 2. Using the Goods Market model explain how an increase in government spending [OR] the use of fiscal policy can achieve full employment. The equilibrium level of output and income, given the marginal propensity to consume and autonomous spending, is at Y0, which is less than the level of full employment (YF ). At this point, the economy is experiencing unemployment i.e. the unemployment gap is YF - Y0 and there are no forces present to ensure that a movement to full employment will occur. z Using Keynes, this gap can be eliminated by increasing the demand for goods, ZZ, since it is the demand for goods that determines the level of output and income. This can be achieved by increasing autonomous spending e.g. 1'C and/or the marginal propensity to consume, c.