Question

2. Balanced Budgets: Suppose that the government passes a balanced budget law. This law - known in popular media as pay-as-you-go - requires the government to meet any increase in government spending with an increase in taxes i.e. G T 1. This question will analyze the consequences of this law on the macro economy under classical assumptions. Consider the following Economy Y =C+I+G C = co + ci(Y-T) I = 1o - IT G=G T=T (a) An increase in government spending and taxes represent a change in the de mand for output. Under classical assumptions supply creates its own demand. Therefore, what is the impact of a change in taxes and government spending on output? (b) What market do you expect to be effected by a change in government spending under a balanced budget rule? (c) What is the equation for Public Savings? (d) What is the equation for Private Savings? (e) Assume that the government increases spending to fund national defense, which with a balanced budget, implies that taxes go up by an equal amount, what effect will this have on the real interest rate? (Hint, you will need to use both (G = T) and (S = 1)) I am looking for an equation that isolates equal to only parameters and exogenous variables.

Answer 1

as Y ca Ita Am increase in G 4 Taxes leads to an equal increase ind ie 2f GAT increases by lo then eqe level of nahon at Inome increases by 10 ble balanced Budge multiples = 1 Good met een output increases whereas budget balanu remains same. Public Saving - Taxes- you spending a T-a Privat saving = Yo-C =Y-T - coral+GT c) net will be no effects on yo crita Yalotay-GT + I-Intatła y-ay-coatt Torã-t = fir mr Y (1-6) - corGT-T+Io nã