Question

Consider a closed economy. Suppose GDP equals $5 trillion, consumption equals $3.25 trillion, the government spends $1 trillion and has a budget deficit of $0.15 trillion.

Question14: Use the numbers from the preceding context, but now suppose that the government cuts taxes by $500 billion and that the consumers save 4/5 of the tax cut and spend the other 1/5. Find out the numerical values of taxes,public saving,private saving, and investment,respectively,after the taxcuts.

a.0.85, 0.15,-0.90, 0.75

b.0.75,-0.65, 1.40, 0.65

c.0.35, 0.15,-0.90, 0.75

d.0.75, 0.15, 1.40, 0.65

e.0.35,-0.65, 1.30, 0.65

f.0.75,-0.15,-0.90, 0.65

Answer 1

Budget Deficit = Government spending - Taxes

Using above infor,ation we have:

0.15 trillion = 1 trillion - Taxes => Taxes = 0.85 trillion(initial tax)

Now tax decrease by 500 billion = 0.5 trillion => New Tax = 0.85 trillion - 0.5 trillion = 0.35 trillion

Public saving = Taxes - Government spending = 0.35 trillion - 1 trillion = -0.65 trillion

Private saving = Y - C - T

So, Initial saving = Y - C - T = 5 trillion - 3.25 trillion - 0.85 trillion = 0.9 trillion

Now for every increase in disposable income by $1 he saves (4/5) = 0.8

So Here his disposable income increases by $0.5 trillion. So saving will increase by 0.8*0.5 trillion = 0.4 trillion.

Hence New Private saving - 0.9 trillion + 0.4 trillion = 1.13 trillion

Investment when economy is closed = National saving = private saving + public saving = -0.65 trillion + 1.13 trillion

= 0.65 trillion

Hence, the correct answer is (e) 0.35,-0.65, 1.30, 0.65