Fiscal Policy in the Keynesian Model (Part II) For questions 1 through 6, assume the economy is at full employment (Y*). Also, suppose that mpc = 0.625 and t = 0.2. Fiscal policy consists of the government's choices of tax rates (t), transfer payments (TR), and spending on goods and services (G). Suppose the government increases government spending (G) by 50. 1. What is the change in the budget deficit (ABD) that results from the rise in G by 50? [HINT: You need to find AY first, but you already did it in Problem Set 10, right?] (a) 30 (b) 40 (c) 50 (d) 16.67 2. Does the budget deficit rise by 50 when government spending (G) increases by 50? (a) Yes, government spending affects the budget directly (b) No, because tax revenues are also affected (c) No, because the tax rate also changes (d) Can't tell, it depends on the value of the other variables like I, NX, TR, etc. Suppose the economy is again at full employment (Y*). Then suppose a decline in business confidence reduces investment (I) by 100. 3. What is the impact of the shock on the budget deficit (ABD)? [HINT: Again, need AY] (a) -60 (b) zero (no impact) (c) 66.67 (d) 40 4. Has the budget deficit changed as a consequence of the decrease in investment? (a) No, no fiscal policy variable (G, TR, t) has changed (b) Yes, the government will respond to a recession by increasing government spending (G) and/or transfer payments (TR) (c) Yes, because of the impact of the change in output on tax revenues (d) No, investment has nothing to do with the budget deficit (BD) Suppose the government wants to respond to the recession caused by the decline in spending due to the drop in investment described in question 8 by using expansionary fiscal policy. That is, the government wants to restore Y* by increasing Y by the same amount as the decrease in Y found in question 8. For example, if Y in question 8 falls by 300 (don't use that number, I'm making it up), then the government would like to increase Y by 300 (i.e., AY = 300). 5. Assuming the government only uses government spending (G) to increase output, the impact of the required AG to restore full employment on the budget deficit (ABD) is [HINT: Here you need AG and AY, but you know both from Problem Set 10] (a) 33.33 (b) 80 (c) 60 (d) 100 6. Assuming the government only uses transfer payments (TR) to increase output, the impact of the required ATR to restore full employment on the budget deficit (ABD) is (a) 120 (b) 93.33 (c) 60 (d) 160