Answer to Question #214338 in Macroeconomics for isaac mensah

Question

1. Suppose you are provided with the following data on the components of aggregate expenditure of Ghana in the year 2020. Consumption function (C) = Gh¢2000m + 0.65Yd Tax function (T) = Gh¢1400m + 0.2Y Gross private domestic investment (I) = Gh¢1800m Government expenditure (G) = Gh¢1970 Exports (X) = Gh¢1300m Imports function (M) = Gh¢1220m + 0.2Y Use the following data above to compute the following: h) What is the value of national savings at equilibrium GDP i) If the full employment output level of the economy is Gh¢9000m, what output gap does Ghana find itself. j) Using a single diagram show (d) and (i) k) By how much should government spending change and in which direction to get the economy to full employment. What sort of fiscal policy is this? l) What will be the fiscal stance of government at full employment level given the fiscal policy pursued in (k) above? m) Will the fiscal policy in (k) above have an impact on the trade balance, national savings? Why?

Answer 1

Solution:

h.). At equilibrium: AD = AS

Y = C + I + G + X – M

C = 2000 + 0.65Yd = 2000 + 0.65(Y – T) = 2000 +0.65(Y – (1400 + 0.2Y))

C = 2000 + 0.65(0.98Y – 1400) = 2000 + 0.637Y – 910 = 2000 – 910 + 0.637Y

C = 1090 + 0.637Y

Y = 1090 + 0.637Y + 1800 + 1970 + 1300 – 1220 + 0.2Y

Y – 0.637Y – 0.2Y = 1090 + 1800 + 1970 + 1300 – 1220

0.163Y = 4940

Y = 30,306.75

The value of national savings = private savings + public savings

Private savings = Y – T – C

T = 1400 + 0.2Y = 1400 + 0.2(30306.75) = 1400 + 6061.35 = 7461.35

C = 1090 + 0.637Y = 1090 + 0.637(30306.75) = 1090 + 19305.40 = 20,395.40

Private savings = 30306.75 - 7461.35 – 20395.40 = 2,450

Public savings = T – G = 7461.35 – 1970 = 5491.35

The value of national savings = 2450 + 5491.35 = 7941.35

 

i.). The output gap is the difference between the actual output of an economy and its potential output

Output gap = Actual output – output at full capacity/ output at full capacity

Actual output = 30306.75

Output at full capacity = 9000

Output gap = 30306.75 – 9000 = 21,306.75

Output gap = 21,306.75

 

j.). Find below the diagram showing (d) and (i):

 

 

k.). Since GDP is 30,306.75 and output at full employment is 9,000, the government spending should be reduced by 1,503 and the direction should be on the left side in order in order to get the economy into full employment.

This is a contractionary fiscal policy in order to slow economic activity by reducing government spending.

 

l.). The fiscal stance of the government at full employment level given contractionary fiscal policy is to decrease its spending and reduce the rates of monetary expansion by limiting the flow of money in the economy.

 

m.). The contractionary fiscal policy will have an impact on the trade balance and national savings. It will lead to trade deficits due to a high level of imports with exports remaining constant.

Similarly, when the government decreases spending or lowers taxes through the policy, this will increase savings leading to an increase in national savings.