The state government collects $400 billion in tax revenue during the current fiscal year and spends...

The state government collects $400 billion in tax revenue during the current fiscal year and spends $415 billion. Which of the following is true?

	a.	The government is running a cash flow surplus.
	b.	The national debt will decrease by about $15 billion.
	c.	The government will cut taxes to cover this shortfall.
	d.	The national debt will increase.

Assume a convex utility function with an interior solution in which a consumer chooses some of each good. Which of the following is NOT represented by the slope of the budget constraint at optimal consumption?

	a.	marginal rate of substitution
	b.	relative price of one good (drawn on horizontal axis) in terms of other good (drawn on vertical axis)
	c.	relative price of one good (drawn on vertical axis) in terms of other good (drawn on horizontal axis)
	d.	ratio of the marginal utilities

Solutions

Expert Solution

Part 1

Tax revenue = $400 billion

Expenditure = $415 billion

Net Deficit = Expenditure - Tax revenue

Net Deficit = $415bn - $400bn = $15bn

a is wrong because the government is running a cash flow deficit (expenditure is more than revenue)

b is wrong because the government will increase, not decrease, when it faces a cash flow deficit

c is wrong because tax cuts can't help cover tax deficits. Cutting tax rates will further reduce tax revenues

d is correct (explanation same as option b)

Part 2

The slope of the budget constraint at optimal consumption is equal to the Marginal Rate of Substitution (MRS).

By definition,

At optimal consumption, Marginal Utility is equal to the price of the good.

Therefore option a,b,d are correct.

c is wrong because MRS is the ratio of relative price of good on X-axis to Y-axis and not the other way round.

Since the question asks for what is NOT represented by the slope of the budget constraint at optimal consumption, c is the right choice

jeff jeffy answered 2 years ago

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