Question

Using the data and equilibrium income seen below (with expansionary fiscal and monetary policy), calculate the budget surplus (deficit)

AD=Y=200+0.8(Y-.0.25Y+1000)+500-25i+2000+1000

Y=0.5Y-25i+4500

0.5Y=4500-25i

Y=9000-50i

Ms=L

4000=0.5Y-75i

Y=8000+150i

8000+150i=9000-50i

150i=1000-50i

200i=1000

i=5

Y=8000+150(5)

Y=8750

Answer 1

Budget surplus or deficit is a measure of the government's budget balance. The formula for the budget balance is given as T-G-TR (T-taxes, G- government spending, TR-transfers). A budget balance is said to be in deficit if if G+TR exceeds T and the budget balance is negative. While if T exceeds G+TR then the budget balance is said to be in surplus and the budget balance is positive.

Based on the given data we can state that G = 2000

Now the consumption function is of the form C = C(bar) + c (Yd);

where Yd = Y-T+TR;

T = t.Y (t-tax rate)

T = 0.25Y and TR = 1000

From your data we see the equilibrium level of Y is 8750. At this level of Y, T= 0.25*8750 = 2187.5

So budget balance = T-G-TR = 2187.5-2000-1000 = -812.5

The negative sign of the budget balance indicates a budget deficit as government spends more in G and TR then it earns in Taxes.

Hence the government has a budget deficit of 812.5 owing to its expansionary policy.