Keynesian Multipliers: Suppose the president would like to stimulate the level of output in the economy by introducing a tax cut. However, he also would like to keep a balanced budget if possible. Let's consider if these two objectives can be consistent with each other. Assume a consumption function C = 100 + 0.75(Y-T), and let G = 100, T = 100, I = 100 (investment is not a function here of the interest rate).
a) First, suppose there is just a tax cut alone, lowering T from 100 to 90. Use the Keynesian multipliers to compute the change in output. Compute also the effect on government saving.Will the president be satisfied (did he get a rise in output and a balanced government budget)?
b) Now suppose he combines the tax cut with spending cuts to keep the budget balanced. So supposed taxes and government spending both are cut from 100 to 90. What is the effect on government saving and output? Will the president be satisfied?
c) Now suppose that the president instead uses a rise in government purchases to stimulate the economy, and then raises taxes to pay for these purchases. In particular, suppose government purchases and taxes both are raised from 100 to 130. Compute the effects on output and government saving. Will the president be satisfied now? Explain how this result is possible and why it is so different from the result in part (b) above.
Keynesian Multipliers: Suppose the president would like to stimulate the level of output in the economy by introducing a tax cut. However, he also would like to keep a balanced budget if possible. Let's consider if these two objectives can be consistent with each other. Assume a consumption function C = 100 + 0.75(Y-T), and let G = 100, T = 100, I = 100 (investment is not a function here of the interest rate).
a) First, suppose there is just a tax cut alone, lowering T from 100 to 90. Use the Keynesian multipliers to compute the change in output. Compute also the effect on government saving.Will the president be satisfied (did he get a rise in output and a balanced government budget)?
b) Now suppose he combines the tax cut with spending cuts to keep the budget balanced. So supposed taxes and government spending both are cut from 100 to 90. What is the effect on government saving and output? Will the president be satisfied?
c) Now suppose that the president instead uses a rise in government purchases to stimulate the economy, and then raises taxes to pay for these purchases. In particular, suppose government purchases and taxes both are raised from 100 to 130. Compute the effects on output and government saving. Will the president be satisfied now? Explain how this result is possible and why it is so different from the result in part (b) above.
