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Lecture 23 Notes

Lecture 23 Notes - ECN 211 Macroeconomic Principles L23...

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11/2/09 1 ECN 211 Macroeconomic Principles L23: Fiscal Policy (continued)
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Re-cap Changes in G had larger effects on real GDP than changes in T (lump-sum taxation) Due to k > t (in absolute terms) What about if changes in G are matched with changes in T. – E.g. increased government spending is financed through increased taxation. 11/2/09 2
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Balance budget changes T = G Original equations C = 100 +0.8Yd I=180 G= 100 X = 200 M= 100 +0.2Yd T= 200 Yd =(Y-T) Now suppose the government increases G by $100 while at the same time finances this by increasing T by $100 remember the original Y* = $900. 3
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Solving for equilibrium Remember AE = C + I + G + X – M AE =100+0.8(Y- 300 )+180+(100+ 100 )+200-[100+0.2(Y- 300 )] AE =100+0.8Y- 240 +180+ 200 +200-100-0.2Y+ 60 AE =400+0.6Y In equilibrium AE=Y => 400+0.6Y =Y =400=0.4Y Y*=1000 4
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Balanced budget multiplier Notice when the government increases spending by $100 and finances this by increasing taxation by $100 then Y* increases by $100 (went from $900 to $1000) Therefore the balanced budget multiplier is always equal to one 11/2/09 5
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Variable Taxation Have focused on lump-sum taxation previously. Going to look at introducing a tax rate (v) Investigate how income taxes affect the spending multiplier. To make things simpler- going to assume a closed economy (no Exports or Imports). 11/2/09 6
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Variable Taxation C =20 + 0.5Yd I=60 G=40 Yd = (Y –T) T = vY v =20% AE = C + I + G= 20+0.5(Y-0.2Y)+60+40 AE= 120+0.5(0.8Y) AE= 120+0.4Y In equilibrium = 120+0.4Y=Y 120=0.6Y Y*=200 11/2/09 7
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