Yd  Y - TDisposable income  Total income - Net taxesC = a + b (Y - T) where Y - T represents disposable income.C = 100 + .9Yd , I = 50, T = 100 and G = 40Calculate the equilibrium level of output.In equilibrium AE = Y. Since AE = C + I + G we can write C + I + G = Y.C = 200 + .8YdDifficulty:M Type: C24. Determine the impact of an increase in government spending of $10 billion when the MPC is .8. Determine the impact of a decrease in government spending of $5 billion when the MPS is .25.25. Discuss an important difference between the spending and tax multipliers.26. Determine the impact of an increase in taxes of $20 billion when the MPS is .25. Determine the impact of a decrease in taxes of $10 billion when the MPS is .2.27. Determine the net impact upon the nation's economy that results from equal increases in spending and taxes of $10 billion when the MPC is .8.28. Determine the net impact upon the nation's economy that results from equal decreases in spending and taxes of $5 billion when the MPC is .75.29. The MPC in Montavada is .75.In a closed public economy aggregate income = C + I + GWe must first calculate the level of equilibrium output.C = 100 + .8 (Y - 500). This reduces to C = 100 +.8Y - 400 orC = -300 +.8Y. In equilibrium - 300 + .8Y + 800 + 200 = Y.C = 100 + .8 (2000 - 200) = $1540.Chapter 9 (22): The Government and Fiscal Policy 9(22) The Government and Fiscal Policy Government in the Economy1. What are the two types of macroeconomic policy channels that are available to the government and describe how they work?The two types of macroeconomic policies are fiscal policy and monetary policy. Fiscal policy refers to the government's spending and taxing behavior or budget policy. Monetary policy refers to the behavior of the Federal Reserve regarding the nation's money supply.Difficulty: E Type: D2. What is discretionary fiscal policy?Changes in taxes or spending that are the result of deliberate changes in government policy to promote full employment, price stability and economic growth.Difficulty: E Type: D3. If the government wants to reduce unemployment what are some ways it should change spending and taxes?In order for the government to reduce unemployment it must either increase government spending, cut taxes, or some combination of two.Difficulty: E Type: C4. Define net taxes.Net taxes refer to the sum total of all taxes collected by the government from firms and households less all transfer payments made to households by the government.163Test Item File 3: Principles of MacroeconomicsDifficulty: E Type: D5. Write the equation for disposable income and identify each component.Yd  Y - TDisposable income  Total income - Net taxesDifficulty: E Type: D6. Given that Yd  C + S, prove that Y  C + S + T. Explain the importance of this relationship.Since Yd  Y - T and Yd = C + S we can then write Y - T  C + S. Adding T to both sides yields: Y  C + S + T.The importance of the relationship is that is says that aggregate income gets cut into three pieces. Government takes a piece, and then households divide the rest between saving and taxes.Difficulty: E Type: D7. Define the budget deficit.The budget deficit is the difference between what the government spends and what it collects in taxes.Difficulty: E Type: D8. How would a strong economy affect the size of the budget deficit?The budget deficit would fall in the face of a strong economy for the simple reason that it means higher incomes, which translate into higher corporate profitand a larger personal income tax base which will lead to higher tax revenues. Difficulty: E Type: D9. Write out the modified algebraic representation of the consumption function when taxes are included.C = a + b (Y - T) where Y - T represents disposable income.Difficulty: E Type: D10. How can government affect investment behavior?The government can affect investment behavior through its tax treatment of depreciation and through changes in interest rates (and investment tax credits.164Chapter 9 (22): The Government and Fiscal Policy Difficulty: E Type: D11. Assume that the economy is in equilibrium at$9 trillion and the government increases spending by $100 billion. What would happen to unplanned inventories and why?Unplanned inventories would fall. The reason is that the economy is currently inequilibrium with aggregate expenditures at $9 trillion. If government increases spending by $100 billion then spending will be greater than the level of output causing a drawing down of inventories.Difficulty: E Type: D12. Assume the following behavioral equations for a macroeconomy:C = 100 + .9Yd , I = 50, T = 100 and G = 40 Calculate the equilibrium level of output.In equilibrium AE = Y. Since AE = C + I + G we can write C + I + G = Y.Rewriting the consumption function yields: 100 + .9 (Y - 100) since Y d = Y - T. This reduces to 10 + .9Y.When added to I and G yields 10 + .9Y + 50 + 40. Combining terms this equals 100 + .9Y. Since this is AE we must then set it equal to Y and solve for Y. We thenget 100 + .9Y = Y. Rearranging and solving for Y yields 1000.Difficulty: E Type: D(All Figures are in Billions of Dollars)Output Taxes DisposableIncomeConsumptionSpendingSaving5000 10007000 10009000 1000PlannedInvestmentGovernmentPurchasesPlannedAggregateExpenditureUnplannedInventoryChange1000 10001000 10001000 100013. Assume that the consumption function for the above economy is C = 1000 + .75Yd fillin the empty cells.Output Taxes DisposableIncomeConsumptionSpendingSaving5000 1000 4000 4000 07000 1000 6000 5500 500165Test Item File 3: Principles of Macroeconomics9000 1000 8000 7000 1000PlannedInvestmentGovernmentPurchasesPlannedAggregateExpenditureUnplannedInventoryChange1000 1000 6000 -10001000 1000 7500 -5001000 1000 9000 0Difficulty: E Type: D14. In a closed economy with a public sector prove that S + T = I + G.In equilibrium aggregate output (income) equals planned aggregate expenditure (AE). By definition, AE equals planned aggregate expenditure (AE). By definition, AE equals C + I + G, and by definition Y equals C + S + T. Therefore, at equilibrium C + S + T = C + I + G. Subtracting C from both sides yields S + T = I + G.Difficulty: E Type: D15. Identify the broad contrasting views regarding the role of government within the macroeconomy. The proponents of government action argue that public policy is needed to insure long-term economic stability and growth because of the disruptions associated with cyclical