You are given the following information about the economy in 2015 (all in billions of dollars):

a. Find equilibrium income. Show that the government budget deficit (the difference between government spending and tax revenues) is $5 billion. 

b. Congress passes the Foghorn-Leghorn (F-L) amendment, which requires that the deficit be zero this year. If the budget adopted by Congress has a deficit that is larger than zero, the deficit target must be met by cutting spending. Suppose spending is cut by $5 billion (to $75 billion). What is the new value for equilibrium GDP? What is the new deficit? Explain carefully why the deficit is not zero.
c. Suppose the F-L amendment was not in effect and planned investment falls to I = 55. What is the new value of GDP? What is the new government budget deficit? What happens to GDP if the F-L amendment is in effect and spending is cut to reach the deficit target?

Transcribed Image Text:

Consumption function: Taxes: Investment function: Disposable income: Government spending: Equilibrium: C = 100 + (.8 X T = -150 + (.25 × Y) I = 60 Y = Y – T %3D G = 80 Y = C + I+ G