1.

(a) Draw a diagram that shows the government's budget balance relative to national income. Explain briefly the vertical intercept of the budget function and its slope.

(b) Using your diagram from (a), show the structural budget balance and a situation in which the actual balance is different from the structural balance.

(c) Based on this diagram, show and explain the difference between the budget effects of automatic stabilization and discretionary fiscal policy.

2.Suppose the government raises its revenue by a net tax of 25 percent on income, t = 0.25. Further suppose that induced expenditure is 0.45Y (based on c = 0.8, t = 0.25 and m = 0.15), autonomous private expenditure is 300 and government expenditure is 400.

(a) What is the government's budget balance?

(b) If the government has outstanding public debt equal to 500 what is the public debt to GDP ratio?

(c) Suppose the government increases its expenditure by 100 without any increase in the tax rate. What are the new equilibrium GDP and the new budget balance? Explain why the change in the government's budget balance is different than the change in government expenditurer