1. Give the economic and non-economic costs of inflation and unemployment. What are the effects of unanticipated inflation on borrowers, lenders, and people with fixed income?
2. Discuss the inventory adjustment mechanism that leads the economy to its equilibrium level. In other words, how do we reach the equilibrium points in the Keynesian model developed in class?
3. Use a Total Expenditure (TE) / Aggregate Supply (AS) with total injections (J) / Withdrawals (W) diagram, to show how tax policy could be used to combat inflation. Use a different diagram to illustrate hoe tax policy could be used to combat unemployment. Carefully explain the effects of the tax change on Savings (S) and Consumption (C).
4. Compute the government spending multiplier for the following MPC’s:
i) MPC = 0.75
ii) MPC = 0.80
iii) MPC = 0.90
Give an intuitive reason why the signs of the two multipliers are different.
Give an intuitive reason why the magnitude of the tax multiplier is smaller
(Hint: it has to do with savings)
5. Assume the government wants to increase spending by $10 billion. With each MPC given above, calculate the total effect on Nominal GDP of the government spending change.
6. Now assume that the government, in order to pay for these extra expenditures, wants to increase taxes by $10 billion. For each MPC given above, calculate the effect on Nominal GDP of the tax change only.
7. Compare the effect on Nominal GDP from the change in government spending, to the change in Nominal GDP due to the change in taxes for each MPC. What are the net effects on Nominal GDP? What does this tell you about the size of the balance budget multiplier (net change in Y/ change in G)?
8. Draw a Keynesian diagram of each fiscal policy option. Using the case where MPC = 0.9, also illustrate where your results from questions 5 & 6 can be depicted graphically.
9.a) Assume MPC = 0.8. Government wants to increase spending by $40 billion on higher education and welfare. In order to pay for these spending, they want to increase taxes by $40 billion. The pilocy makers say that this is better for the overall economy. Calculate the change in consumption, change in savings, change in withdrawals, change in injections, net change in Nominal GDP, and the balance budget multiplier.
b) Draw a graph and show the movements.
c) Some argued that increase in taxes would harm the consumers and the economy. They say that the government should cut taxes by the $40 billion and reduce government spending by $40 billion. Calculate the change in consumption, change in savings, change in withdrawals, change in injections, net change in Nominal GDP, and the balance budget multiplier.
d) Draw a graph and show the movements.
e) What policy is better for the overall output of the economy?