Question

The government of Osiris believes in balancing its budget over a seven-year cycle. Over the first six years, it has maintained its spending at $180 billion and its MTR at 0.25. (There are no autonomous taxes in Osiris). Column 2 of the table below shows the level of GDP in each of the first six years in the cycle.

a. Complete the table below. Round your answers to nearest whole number.

(1) Year	(2) GDP ($ billion)	(3) Tax Revenue ($billion)	(4) Government Spending ($billion)	(5) Deficit/Surplus
1	720		180
2	670		180
3	650		180
4	730		180
5	740		180
6	755		180

Suppose that the estimated level of GDP in Year 7 is projected to be $700.

b. What level of government spending (assuming no change in the tax rate) for the government of Osiris to end the seven-year cycle with its budgetary goal on target?

    Government spending would have to be $  .

c. Alternatively, what should the new tax rate be (assuming no change in government spending) for the government of Ran to end the seven-year cycle with its budgetary goal on target? Round your answer to 2 decimal places.

    Tax rate should be changed to  %.

Answer 1

Year	GDP ($ billion)	Tax revenue ($ billion)	Government spending ($ billion)	Deficit / surplus
1	720	180	180	0 (balanced budget)
2	670	167.5	180	-12.5 (deficit)
3	650	162.5	180	-17.5 (Deficit)
4	730	182.5	180	2.5 (surplus)
5	740	185	180	5(surplus)
6	755	188.75	180	8.75 (surplus)

Tax revenue = MTR * GDP.

Budget balance = Tax revenue - Government spending.

There is balanced budget, if Tax revenue and Government spending are equal. In this case, budget balance is zero

There is deficit budget, if Tax revenue is less than government spending. In this case budget balance is negative.

There is surplus budget, if tax revenue is more than government spending.In this case budget balance is positive.

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(b) For year 7, the projected Y is $700 billon.

MTR = 25%

Tax revenue in 7th year = 0.25 * $700 billion

=> Tax revenue in 7th year = $175 billion.

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For balanced budget, tax revenue = government spending.

=> Hence, in 7th year the government spending should be $175 billion.

Answer: Government spending would have to be $175 billion.

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(c) If government spending is unchanged at $180 billion in 7th year, then the tax revenue should be also $180 billion to achieve the balanced budget goal.

Because, for balanced budget, tax revenue = government spending.

Tax revenue = MTR * GDP

=> $180 billion = MTR * $700 billion

=> MTR = ($180 billion / $700 billion)

=> MTR = 25.71%

Answer: Tax rate should be changed to 25.71%