Question

1. In a closed economy Y = $18 trillion, national saving = $5.5 trillion, consumption is equal to government expenditure. What is the government expenditure?
2. Skyline Chili wants to finance the purchase of new equipment for its restaurants. The firm has limited internal funds, list two options that are available for Skyline to seek the funding.
3. What do you mean by Kuwait government has a budget deficit for the year 2020?
4. Using a graph explain the impact of Kuwait government introducing a tax on interest/profit income. Explain what would happen to real interest rates and the equilibrium quantity of loanable funds?
5. Explain what would happen to standard of living in Kuwait as the Kuwait government’s decision to not to undertake any mega projects?

Answer 1

In a closed economy the Y is given as $18 trillion, national savings is $5.5 trillion and since, based on the fundamental macroeconomic accounting identity, the national savings equals to the aggregate investment expenditure in the economy, the aggregate investment expenditure or I would also be $5.5 trillion. The aggregate consumption expenditure on goods and services or C is equal to the aggregate government expenditure G. Now, we know, that based on the expenditure method to calculate the national GDP in a closed economy, Y=C+I+G

Therefore, based on the expenditure method to calculate the national GDP of a closed economy, we can state, in this case:-

Y=C+I+G

$18 trillion=C+$5.5 trillion+G

$18 trillion-$5.5 trillion=C+G

$12.5 trillion=C+G

Now, since C and G are equal, both will be=$12.5 trillion/2= $6.25 trillion. Hence, the government expenditure or G, in this case would be $6.25 trillion.

Considering limited financial funds or resources available to Skyline Chili to purchase new equipment for its restaurant, the company can undertake a business loan from any commercial bank/credit agency/other financial institutions which would essentially finance or liquidate the purchase of the new equipment by the company by providing a certain amount of business loan at a particular periodic interest rate. The company or the Skyline Chili is officially or legally liable to payoff the entire principle amount of the loan along with the periodic interest payments. Alternatively, Skyline Chili can also approach private capital or business investors to fund or finance the purchase of the concerned new equipment in its restaurant. In this case, the company is officially and legally liable to pay a certain percentage of its economic or financial return on the specific investment to the investor/s on the basis of the respective investment amount on the proposed project or endeavor.

Budget deficit by any government fundamentally signifies that the overall government expenditure has exceeded the total tax revenue collected by the government. Therefore, a budget deficit experienced by the Kuwait government in 2020 basically implies that the overall expenditure level of the Kuwait government has been higher than the overall tax revenue collected or accumulated by the Kuwait government in 2020.

Figures 1 and 2 in the document attached below combiningly illustrate the impact of interest/profit income tax implemented by the Kuwait government. A tax imposition on the interest/profit income of the firms or companies would reduce their net profit levels thereby decreasing the aggregate investment expenditures by the firms or companies on various business and commercial projects or investments as now they would have relatively less profitability or savings level from their profits due to tax imposition to invest in further business or capital investment projects and undertakings. Hence, the aggregate investment expenditure by the firms or companies or I would decrease thereby leading to a reduction in the aggregate demand or AD in the Kuwaiti goods market as shown in figure-1. Figure-1 represents the Kuwaiti goods market where AD,SRAS, and LRAS denote the aggregate demand, short-run aggregate supply, and long-run aggregate supply and AD1, SRAS1, and LRAS1 represent the initial or original AD, SRAS, and LRAS prior to the imposition of the interest/profit income tax imposed by the Kuwait government on the firms or companies. The price level of goods and services and the real output in the Kuwaiti goods market are denoted as P and Y respectively. Now, the tax imposition, the I declines as explained above leading to a decrease in AD as well as indicated by a downward or leftward shift of the AD curve from its initial position at AD1 to AD2. Note that as a result, the equilibrium price level of goods and services and the real output drop form their initial level at P*1 and Y*1 to P*2 and Y*2 respectively in Kuwaiti goods market.

Now, figure-2 illustrates the impact of the interest/profit income tax imposition by the Kuwaiti government on the IS-LM model and the interest rate in the Kuwaiti economy. The IS1 and LM1 represent the initial or original IS and LM curves in the economy prior to the tax imposition and the interest rate and the real output are denoted as r and Y respectively. Note that a downward or leftward shift in the AD curve from AD1 to AD2 due to the tax imposition by the Kuwaiti government corresponds to a leftward or downward shift in the IS curve from its original level at IS1 to IS2 and holding the LM curve unchanged at its initial position at LM1, the equilibrium interest rate and the real output both decline from their original level at r*1 and Y*1 to r*2 and Y*2 respectively as indicated in figure-2. Therefore, based on figure-2, an imposition of interest/profit income by the Kuwait government on the firms or companies would cause a reduction in the interest rate in the Kuwaiti economy and the money or loanable fund market. It essentially implies the money demand would increase in the money or loanable funds market and holding the level of money supply unchanged or constant, an increase in the money demand in the loanable funds market would lead to an increase in the equilibrium quantity of loanable funds.

As the Kuwait government decides not to undertake any large-scale or mega investment projects, the aggregate or overall government expenditure or G in the Kuwaiti economy would decrease thereby leading to a reduction in aggregate demand or AD in the Kuwaiti goods market which would consequently lead to a reduction in the equilibrium price level of goods and services exhibiting a deflationary effect and the real output as well, holding the aggregate supply of goods and services constant. Therefore, the real output decreases in the Kuwaiti economy due to lower government investment on large-scale or mega projects implying a corresponding decline in the real income of people or the real GDP and the standard of living in Kuwait as well.