Question

10. Suppose the government surplus is 3 percent of real GDP, but economists say that the structural surplus is 2 percent. Is real GDP currently above or below potential GDP? Why? Draw the diagram showing this situation.

Answer 1

The structural surplus/deficit is the full employmnet surplus/ deficit that is always present in the economy. The deficit/surplus that is present in the economy when the economy is operating at its full employmnet level is called the structural deficit/surplus. Any deficit/surplus that occurs due to cyclical fluctuation is called the cyclical deficit/surplus. The total surplus in the economy is given by structural plus cyclical deficit/surplus.

In this case, the total surplus is above the structural surplus in this ecoomy thus economy is operating above potential GDP. This is because, the tax revenue generated above the government expenditure is greater than what it is in full employment. When the economy is in expansion the autometic stabilizers or the benefit program decreases and the income tax revenue rises as income rises above potential. Thus the government generates revenue above its spending and the cyclical surplus is above structural surplus.

This is shown in the figure below

Deficit Potential GDP Actual GDP Structural Surplus Real GDP Cyclical Surphus Surplus