Question

Assume an economy in which consumers tend to spend $0.80 more for every $1 increase in real GDP. Assume also that (1) income is taxed at a rate of 20%, (2) that, independent of real income, another $100 billion in taxes are levied, (3) that given their real net worth, their overall level of confidence and interest rates, consumers will spend $660 billion, (4) that businesses plan to spend 500 billion on new facilities, repairs, new tools and machinery, and additions to inventory, and (5) that real government spending, G, is $500 billion. All figures are in base year 2012 dollars Given total tax revenues in this example of $977.78 billion and government spending of $500 billion this economy's government is: a. running a budget surplus and the national debt, in real terms is falling. b. impossible to say from the information given c. running a budget deficit and the national debt, in real terms is growing.

Answer 1

When government spending is greater than the tax revenue then in that case government has a budget deficit. In case of budget deficit, government has to borrow and, therefore, national debt tends to grow.

When government spending is less than the tax revenue then in that case government has a budget surplus. In case of budget surplus, the government has extra resources and can use them to payoff debt and, therefore, national debt tends to decrease.

In the given case,

Tax revenue = $977.78 billion

Government spending = $500 billion

It can be seen that tax revenue is greater than the government spending. Therefore, there is a budget surplus and there will be fall in the national debt.

Hence, the correct answer is the option (a) [running a budget surplus and the national debt, in real terms is falling].