econ_100B-18

econ_100B-18 - ECONOMICS 100B Professor Steven Wood...

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Professor Steven Wood 10/28/08 Lecture 18 ASUC Lecture Notes Online is the only authorized note-taking service at UC Berkeley. Do not share, copy or illegally distribute (electronically or otherwise) these notes. Our student-run program depends on your individual subscription for its continued existence. These notes are copyrighted by the University of California and are for your personal use only. D O N O T C O P Y Sharing or copying these notes is illegal and could end note taking for this course. *Note: Reference to Professor Wood’s Power Point Slides today will be noted as (18-1), for “Power Point #18: Government Spending and its Financing Part 1, Slide #1.” LECTURE Last week we talked about monetary policy, so this week we will talk about fiscal policy. It’s important to think about how fiscal policy and budget interact. We’ll talk about fiscal policy and how it affects budget balances, and we’ll also talk about measuring budget change. Lastly, we will talk a bit about effective short-run fiscal policy. To start with, we need to think about couple of things we’ve already learned. When we think about government spending, we treat this as an exogenous variable. We will keep doing this; in other words, we’re not going to try to explain how much government spending is taking place in terms of other economic variables. There just isn’t any consistent relationship. The Congress spends as much as they want to spend. Up to this point, tax has also been an exogenous variable. But this will no longer be the case, because most tax systems are actually income tax systems. How much tax revenue is generated depends on level of income. So the easiest way to say that is that our tax revenue will equal tax rate (“t”) multiplied with income (“Y”): T = tY. So we will now make tax endogenous variable, and the tax rate an exogenous variable. If this is the case, then we can see that the budget balance for the economy will equal: T – G = tY – G “tY” is also referred to as “induced budget; this simply means that it depends on the level of economic activity. So it’s very clear then that if there is a change in Y, T will change, and this also means that the budget balance will change. Now all of a sudden, the budget balance also becomes an endogenous variable. If we were to graph this, it might look something like this: First, we have to recognize that in that equation, T- G could be a positive number (if T is greater than G) or a negative number (if G is greater than T) or zero. On our horizontal axis, we want our economic input. If income was zero, the budget balance would be –G. This is as big as deficit can be. As income grows, tax revenues will also rise, so the budget balance will also improve. The slope of this line equals the tax rate. Needless to say, the higher the tax rate, the steeper
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econ_100B-18 - ECONOMICS 100B Professor Steven Wood...

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