Question

Crack economists in the economy of Xer estimate the following (all figures in billions):

            Real Output                                        1000

            Government Purchases                       200

            Total Net Taxes                                  200

            Investment (planned)                         100

            a          You are asked by the business editor of the Xer Gazette to predict the

events of the next few months. By using the data given, can you make a forecast? (Assume that investment is constant).

b          If no changes were made, at what level of GDP, would the economy of Xer settle?

c          If government purchases are cut by 25 billion, what effect would have these cuts on economy?

Answer 1

Hi,

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Question:

Answer:

a). Answer:

Macroeconomic data (in billion)

Real Output = 1000

Government Purchases =   200

Total Net Taxes = 200

Investment (planned) = 100

Government Purchase: Government purchase is all the government spending on goods, services and other spending excluding government's transfer payment and other social securities benefits.

Total Net Taxes:  The net of tax is the amount left after taxes have been subtracted.

Investment (planned): It is the amount of desired investment not actual.

Here,

Government purchase is equal to 20% of real output.

Net Taxes is equal to government purchase and 20% of real output.

Investment (planned) is half of the government purchase and 10% of real output.

[Assume that investment is constant]

If we normally talk about the government spending to GDP then it is approximately 35-40% in advance countries and 10-20% in maximum developing nation. Government purchases paly a an important role in economic government. Increasing government expenditure increase the aggregate demand in the economy that increase the GDP growth and price level. Its creat employment opportunities, income level and skills set of the people that is very helpful for the economic growth. But it is better in short-run, in long run its increase budget deficit and GDP-Debt ratio. So, in long-run policymakers should be ready to reduce government spending once the economy is recovered so as to prevent inflation.

Here, Government purchasing and total net taxes is better. High total net taxes is also boost the consumption habit and increase Aggregate Demand (AD) level. Consumption contribute for 61% in aggregate demand. Other side, Increasing government expenditure increase the aggregate demand in the economy that increase the GDP growth and price level. Its creat employment opportunities, income level and skills set of the people that is very helpful for the economic growth. So, it is a good sign for the economy. Its gives the better future prediction for economic growth rate.

b). Answer:

If no changes were made, at what level of GDP then then then real GDP grow but less than nominal GDP because of increasing price level. So, here, the economy of Xer would settle on higher real GDP.

c). Answer:

If government purchases are cut by 25 billion then new government purchases will be 175 billion that is 17.5% of total output. So, it will affect the aggregate demand and AD will reduce and reducing AD will negatively affect the GDP growth (total output level) and price level. So,  If government purchases are cut by 25 billion then it will reduce the future prediction for economic growth rate. Because we have seen above that . t. Increasing government expenditure increase the aggregate demand in the economy that increase the GDP growth and price level. Its creat employment opportunities, income level and skills set of the people that is very helpful for the economic growth. Further reducing government purchases will affect the income level of the people so it will reduce the total net tax also that will reduce the disposable income. Reducing disposable income will reduced the consumption level that will negatively affect the AD level. Increasing AD reduce the total output level and price level.

Thank You