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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
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
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
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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