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C H A P T E R 12
G O V E R N M E N T E X P E N D I T U R E
Learning Outcomes
? You should be able to distinguish between public production and public services.? You should understand the implications of a permanent change in government purchases.? You should understand the implications of temporary changes Ans. 1
a. Prior to the 1996 revisions, the services provided by the capital would have added nothing to GDP . If they were given to the private sector and purchased by the government, GDP would increase. For example if government built a marina for coast guard patrol boats, the services would not be counted as GDP . If the government gave Key Terms and Concepts
real disposable income (p. 221)Social Security (p. 217)
government’s budget constraint (p. 219)lump-sum taxes (p. 219)term structure of real interest rates (p. 229)
Worked Problems
Ques. 1Public ownership of capital and the national accounts
Until the revision of 1996, the U.S. national accounts included in GDP the government’s purchases of goods and services but took no account of the flow of services on government-owned capital. The accounts also did not subtract depreciation of this capital to calcu-Key Equations
Key equation (government budget constraint):
total usees of funds ? total sources of funds
(12.1)
G t ? V t ? T t ? (M t ? M t ? M t ?1)/P t
real purchases ? real transfers ? real taxes ? real revenue
from money creation
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Chapter Summary
Figure 12.1
Total Government Expenditure,
Purchases, Transfers, and Interest Payments
.5
in, G , does not impact the marginal productivity of capital and therefore does not change the amount of labor input in the economy leaving real GDP and Y unchanged.
? You should understand the implications of temporary changes in government purchases.
Figure 12.7
Cyclical Behavior of U.S. Real GDP
and Government Purchases
.06
Key Graphs
? You should be able to distinguish between public production and public services.
Government uses it real purchases of goods and services, G , to provide services to households and businesses free of charge. These services can include national defense, enforce-ment of laws and private contracts, police protection and etc.
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C H A P T E R 13TA X E S
Learning Outcomes
? You should understand the basic differences between various types of taxation.? You should understand the implications of an increase in taxation of labor income.
Ques. 1The flat-rate tax
Some U.S. economists advocate shifting from the graduated individ-ual income tax to a flat-rate tax. Under the new system, there would be few deductions from taxable income, and the marginal tax rate Ans. 1
a. If the elimination of deductions permits government to reduce the marginal tax rate on labor income, then the substitution effect predicts an increase in labor income. More labor employed will make capital more productive and should result in an increase in capacity utilization rates. The net result would be to raise GDP , Y .Key Terms and Concepts
average tax rate (p. 238)double taxation (p. 241)? at-rate tax (p. 240)adjusted gross income (p. 239)after-tax real interest rate (p. 245)after-tax real wage rate (p. 242)graduated-rate tax (p. 238)
La? er curve (p. 248)
marginal tax rate (p. 238)
Worked Problems
? You should understand the implications of an increase in taxation on asset income.? You should understand the overall effect on the labor supply of an increase in government purchases financed by a tax on labor income.
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Chapter Summary
Figure 13.5 Effect of an Increase in the Labor-
Income Tax Rate on the Labor Market
(L s )?
w /P
L s
The higher marginal tax In the short run an increase in the marginal tax rate on asset income does not change the quantity of capital services, the demand for labor or the supply of labor. The market clear-ing wage rate does not change. Thus our conclusion is that a change in the marginal tax rate does not change GDP . However, in the long run, an increase in the marginal tax rate on assets will lower gross investment, I , resulting in a lower capital stock Figure 13.6
Effect of an Increase in the Labor-Income Tax Rate on the Market for Capital Services
R /P
(?K )d
(?K )s
Key Graphs
? You should understand the basic di? erences between various types of taxation.
Some taxes fall on income like individual income tax and cor-porate pro? t taxes. Other forms of tax fall on wealth owners an example might be property tax.
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C H A P T E R 14P U B L I C
D
E B T
Learning Outcomes
? You should understand the relationships between deficits, public debt and government bonds ? You should be able to distinguish between public, private and national savings.? You should understand the implications of the Ricardian Equivalence proposition Key Equations
Key equation (expanded government budget constraint):
(14.1) G t ? V t ? i t ?1 ? (B t ?1 g /P t
) ? T t ? (B t g ? B t ?1
g )/P t ? (M t ? M t ?1)/P t
real purchases ? real transfers ? real interest payments ?
real taxes ? real debt issue ? real revenue from money
creation
Ques. 1
The income effect from a budget deficit
Suppose that, in year 1, the government cuts current, lump-sum taxes and runs a budget deficit. Assume that the real public debt remains constant in future years. Also, no changes occur in govern-ment purchases of goods and services, G , or in real transfers, V . Ana-effect would increase current consumption and reduce investment. On the other hand, if people care about the the finances of the next generation, they will accumulate savings which will be left to their children (bequest motive) and the income effects will be eliminated.
b. If people don’t have any children then they will be able to shift the burden of the debt onto other people’s children. The bequest Key Terms and Concepts
fully funded system (p. 269)
national saving (p. 258)
open-market operations (p. 270)pay-as-you-go system (p. 269)public debt (p. 252)
balanced budget (p. 256)budget de? cit (p. 252)budget surplus (p. 256)
burden of the public debt (p. 266)? scal policy (p. 261)
public investment (p. 256)
Ricardian equivalence theorem (p. 259)strategic budget de? cits (p. 265)tax-rate smoothing (p. 264)
Worked Problems
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Chapter Summary
Figure 14.1
Ratio of U.S. Public Debt to GDP,
1790–2005
1.2in real savings is o? set by the government real increase in dis-savings and their will be no change in national savings.? You should understand the potential impacts various ? scal policy tax changes.
Fiscal policy changes in the form of tax cuts can come in vari-ous di? erent forms. Lump sum tax cuts do not impact an real Figure 14.3
Ratio of U.S. Real Budget Deficit to
Real GDP, 1954–2005
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Key Graphs
? You should understand the relationships between de? cits, public debt, government bonds and budget surplus.
When a governments tax revenues fall short of expenditures the government runs a budget de? cit. The accumulation of those de? cits across years is the nations public debt. Govern-ments issue government bonds as ? nancial vehicles to borrow