Three-sector Model (1)
description
Transcript of Three-sector Model (1)
![Page 1: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/1.jpg)
1
Simple Keynesian Model
National Income DeterminationThree-Sector National Income
Model
![Page 2: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/2.jpg)
2
Outline Three-Sector Model Tax Function T = f (Y) Consumption Function C = f (Yd) Government Expenditure Function G=f(Y) Aggregate Expenditure Function E = f(Y) Output-Expenditure Approach: Equilibri
um National Income Ye
![Page 3: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/3.jpg)
3
Outline Factors affecting Ye Expenditure Multipliers k E
Tax Multipliers k T
Balanced-Budget Multipliers k B
Injection-Withdrawal Approach: Equilibrium National Income Ye
![Page 4: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/4.jpg)
4
Outline Fiscal Policy (v.s. Monetary Policy) Recessionary Gap Yf - Ye Inflationary Gap Ye - Yf Financing the Government Budget Automatic Built-in Stabilizers
![Page 5: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/5.jpg)
5
Three-Sector Model With the introduction of the
government sector (i.e. together with households C, firms I), aggregate expenditure E consists of one more component, government expenditure G.
E = C + I + G Still, the equilibrium condition is
Planned Y = Planned E
![Page 6: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/6.jpg)
6
Three-Sector Model Consumption function is positively
related to disposable income Yd [slide 37 of 2-sector model],
C = f(Yd)C= C’C= cYdC= C’ + cYd
![Page 7: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/7.jpg)
7
Three-Sector Model National Income Personal Income
Disposable Personal Income w/ direct income tax Ta and transfer
payment Tr Yd Y Yd = Y - Ta + Tr
![Page 8: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/8.jpg)
8
Three-Sector Model Transfer payment Tr can be treated
as negative tax, T is defined as direct income tax Ta net of transfer payment Tr
T = Ta - Tr Yd = Y - (Ta - Tr) Yd = Y - T
![Page 9: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/9.jpg)
9
Three-Sector Model The assumptions for the 2-sector
Keynesian model are still valid for this 3-sector model [slide 24-25 of 2-sector model]
![Page 10: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/10.jpg)
10
Tax Function T = f(Y)
T = T’ T = tY T = T’ + tY
![Page 11: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/11.jpg)
11
Tax Function
T = T’
Y-intercept=T’
slope of tangent=0
T = tY
Y-intercept=0
slope of tangent=t
T = T’ +tY
Y-intercept=T’
slope of tangent=t
![Page 12: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/12.jpg)
12
Tax Function Autonomous Tax T’
this is a lump-sum tax which is independent of income level Y
Proportional Income Tax tY marginal tax rate t is a constant
Progressive Income Tax tY marginal tax rate t increases
Regressive Income Tax tY marginal tax rate t decreases
![Page 13: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/13.jpg)
13
Consumption Function C = f(Yd) C = C’
C = C’ C = cYd
C = c(Y - T) C = C’ + cYd
C = C’ + c(Y - T)
![Page 14: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/14.jpg)
14
Consumption FunctionC = C’ + c(Y - T)
T = T’
C = C’ + c(Y - T’) C = C’- cT’ + cY
slope of tangent = c T = tY
C = C’ + c(Y - tY) C = C’ + (c - ct)Yslope of tangent = c - ct
T = T’ + tYC = C’+c[Y-(T’+tY)]C = C’ - cT’ + (c - ct) Y
slope of tangent = c - ct
![Page 15: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/15.jpg)
15
Consumption FunctionC = C’ + c (Y - T’)
Y-intercept = C’ - cT’
slope of tangent = c = MPC
slope of ray APC when Y
![Page 16: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/16.jpg)
16
Consumption FunctionC = C’ + c (Y - tY)
Y-intercept = C’
slope of tangent = c - ct = MPC (1-t)
slope of ray APC when Y
![Page 17: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/17.jpg)
17
Consumption Function C = C’ + c [Y - (T’ + tY)]
Y-intercept = C’ -cT’
slope of tangent = c - ct = MPC (1-t)
slope of ray APC when Y
![Page 18: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/18.jpg)
18
Consumption Function C = C’ - cT’ + (c - ct)Y
C’ OR T’ y-intercept C’ - cT’ C shift upward
t c(1-t) C flatter
c c(1-t) C steeper y-intercept C’ - cT’ C shift downward
![Page 19: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/19.jpg)
19
Government Expenditure Function
G only includes the part of government expenditure spending on goods and services, i.e. transfer payments Tr are excluded.
Usually, G is assumed to be an exogenous / autonomous function
G = G’
![Page 20: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/20.jpg)
20
Government Expenditure Function
Y-intercept = G’
slope of tangent = 0
slope of ray when Y
![Page 21: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/21.jpg)
21
Aggregate Expenditure Function
E = C + I + Ggiven C = C’ + cYdT = T’ + tYI = I’G = G’
E = C’ + c[Y - (T’+tY)] + I’ + G’ E = C’ - cT’ + I’+ G’ + (c-ct)Y E = E’ + c(1-t) Y
![Page 22: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/22.jpg)
22
Aggregate Expenditure Function
E = C’ - cT’ + I’ + G’ + (c - ct)Y E = E’ + (c - ct)Y
given E’ = C’ - cT’ + I’ + G’ E’ is the y-intercept of the
aggregate expenditure function E c - ct is the slope of the aggregate
expenditure function E
![Page 23: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/23.jpg)
23
Aggregate Expenditure Function
Derive the aggregate expenditure function E if T = T’
E = C’ - cT’ + I’ + G’ + cY y-intercept = C’ - cT’ + I’ + G’ slope of tangent = c
![Page 24: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/24.jpg)
24
Aggregate Expenditure Function
Derive the aggregate expenditure function E if T = tY
E = C’ + I’ + G’ + (c-ct)Y y-intercept = C’ + I’ + G’ slope of tangent = (c-ct)
![Page 25: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/25.jpg)
25
Aggregate Expenditure Function
Derive the aggregate expenditure function E if T = T’ and I = I’ + iY
E = C’ - cT’ + I’ + G’ + (c + i)Y y-intercept = C’ - cT’ + I’ + G’ slope of tangent = (c + i)
![Page 26: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/26.jpg)
26
Aggregate Expenditure Function
Derive the aggregate expenditure function E if T = tY and I = I’ +iY
E = C’ + I’ + G’ + (c - ct +i )Y y-intercept = C’ + I’ + G’ slope of tangent = (c - ct +i )
![Page 27: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/27.jpg)
27
Aggregate Expenditure Function
Derive the aggregate expenditure function E if T = T’ + tY and I = I’ +iY
E = C’ - cT’ + I’ + G’ + (c - ct +i)Y y-intercept = C’ - cT’ + I’ + G’ slope of tangent = (c - ct +i)
![Page 28: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/28.jpg)
28
Output-Expenditure Approachw/ T = T’ + tYw/ C = C’ + cYd
Y
C C = C’ + cYd = C’ + cY
C = C’ - cT’ + c(1-t)Y
C’C’ -cT’
Slope of tangent = c = MPC =C/Yd
Slope of tangent = c (1-t) = (1-t)*MPC MPC
2-Sector
3-Sector
![Page 29: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/29.jpg)
29
Y
I, G, C, E, Y
Planned Y = Planned E
Y=E
![Page 30: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/30.jpg)
30
Output-Expenditure ApproachI = I’ exogenous function
E = E’ + (c - ct) Y [slide 21-22] In equilibrium, planned Y = planned E Y = E’ + (c - ct) Y (1- c + ct) Y = E’ Y = E’
E’ = C’ - cT’ + I’ + G’k E =
1
1 - c + ct
1
1 - c + ct
![Page 31: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/31.jpg)
31
Output-Expenditure ApproachI= I’+iY endogenous function E = E’ + (c - ct + i) Y [slide 27] In equilibrium, planned Y = planned E Y = E’ + (c - ct + i) Y (1- c + ct - i) Y = E’ Y = E’
E’ = C’ - cT’ + I’ + G’k E =
1
1 - c - i + ct
1
1 - c - i + ct
![Page 32: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/32.jpg)
32
Output-Expenditure ApproachT = T’ exogenous functionI = I’ + iY
E = E’ + (c + i) Y [slide 25] In equilibrium, planned Y = planned E Y = E’ + (c + i) Y (1 - c - i) Y = E’ Y = E’
E’ = C’ - cT’ + I’ + G’k E =
1
1 - c - i
1
1 - c - i
![Page 33: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/33.jpg)
33
Factors affecting Ye Ye = k E * E’ In the Keynesian model, aggregate
expenditure E is the determinant of Ye since AS is horizontal and price is rigid.
In equilibrium, planned Y = planned E E = C’ - cT’ + I’ + G’ + (c - ct + i) Y Any change to the exogenous variables
will cause the aggregate expenditure function to change and hence Ye
![Page 34: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/34.jpg)
34
Factors affecting Ye Change in E’ If C’ I’ G’ E’ E Y If T’ C’ - c T’ E’ by - c T’E Y
Change in k E / slope of tangent of E If c i E steeper Y If c C’ - c T’ E’ E Y If t E steeper Y
![Page 35: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/35.jpg)
35
Y
I, G, C, E, Y Y=E
![Page 36: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/36.jpg)
36
Y
I, E, Y I’
I’
E’ = I’
Ye = k E E’
![Page 37: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/37.jpg)
37
Y
G, E, YG’
![Page 38: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/38.jpg)
38
Y
C, E, Y C’
![Page 39: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/39.jpg)
39
Y
C, E, Y T’
C by -cT’
![Page 40: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/40.jpg)
40
Y
I, E, Y i
![Page 41: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/41.jpg)
41
Digression Differentiation y = c + mx differentiate y with respect to x dy/dx = m
![Page 42: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/42.jpg)
42
Expenditure Multiplier k E Y = k E * E’ E’ = C’ - cT’ + I’ + G’ k E = if I=I’ & T=T’+tY
k E = if I=I’+iY & T=T’+tY
k E = if I=I’+iY & T=T’
1
1 - c + ct 1
1 - c + ct - i
1
1 - c - i
![Page 43: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/43.jpg)
43
Expenditure Multiplier k E Whenever there is a change in the
autonomous spending C’ I’ or G’ the national income Ye will change by a multiple of k E.
It actually measures the ratio of the change in national income Ye to the change in the autonomous expenditure E’
Ye/E’ = k E
![Page 44: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/44.jpg)
44
Tax Multiplier k T
Y = k E * ( C’ - cT’ + I’ + G’) k T = if I=I’ & T=T’+tY
k T = if I=I’+iY & T=T’+tY
k T = if I=I’+iY & T=T’
-c
1 - c + ct -c
1 - c + ct + i
-c
1 - c - i
![Page 45: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/45.jpg)
45
Tax Multiplier k T
Any change in the lump-sum tax T’ will lead to a change in the national income Ye by a multiple of k T in the opposite direction since k T takes on a negative value
Besides, the absolute value of k T is less than the value of k E.
![Page 46: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/46.jpg)
46
Balanced-Budget Multiplier k B G’ E’ E Ye by k E times T’ E’ E Ye by k T times If G’ = T’ , the change in Ye can be
measured by k B Y/ G’ = k E Y/ T’ = k T k B = k E + k T k B = + = 1
1
1-c
-c
1-c
![Page 47: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/47.jpg)
47
Balanced-Budget Multiplier k B The balanced-budget multiplier k B
= 1 when t=0 & i=0 What is the value of k B if t 0 ? If k B = 1 an increase in government
expenditure of $1 which is financed by a $1 increase in the lump-sum income tax, the national income Ye will also increase by $1
![Page 48: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/48.jpg)
48
Injection-Withdrawal Approach
In a 3-sector model, national income is either consumed, saved or taxed by the government
Y = C + S + T Given E = C + I + G In equilibrium, Y = E C + S + T = C + I + G S + T = I + G
![Page 49: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/49.jpg)
49
Injection-Withdrawal Approach
Since S + T = I + G S I T G I > S T > G I < S T < G (Compare with 2-sector model) In equilibrium S = I
![Page 50: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/50.jpg)
50
Injection-Withdrawal Approach
T = T’ + tY S = -C’ + (1-c) Yd S = -C’ + (1 - c)[Y -_(T’ + tY)] S = -C’ + (1 - c)[Y - T’ - tY] S = -C’ + Y - T’ - tY - cY + cT’ + ctY S = -C’ + cT’ -T’ - tY + Y - cY + ctY S = -C’ + cT’ - (T’ + tY) + Y - cY + ctY
![Page 51: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/51.jpg)
51
Injection-Withdrawal Approach
S + T = -C’ + cT’ -(T’+ tY) + Y - cY + ctY +T S + T = -C’ + cT’ + Y - cY + ctY In equilibrium, S + T = I + G -C’ + cT’ + Y - cY + ctY = I’ + G’ (1- c + ct)Y = C’ - cT’ + I’ + G’ Ye = k E * E’ E’ = C’ - cT’ + I’ + G’ [slide 30]
![Page 52: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/52.jpg)
52
Use the Injection-Withdrawal Approach to solve for Ye if T=T’
![Page 53: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/53.jpg)
53
Fiscal Policy The use of government expenditure and
taxation to achieve certain goals, such as high employment, price stability.
Discretionary Fiscal Policy Expansionary Fiscal Policy (when Yf > Ye) Contractionary Fiscal Policy (when Yf < Ye)
Automatic Built-in Stabilizers Proportional / Progressive Tax System Welfare Schemes
![Page 54: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/54.jpg)
54
Expansionary Fiscal Policy Recessionary/Deflationary Gap Yf-Ye
Y-line
E = E’ + (c -ct) Y
Ye
E = E” + (c-ct) Y
G’
Yf
Y= k E * E’
Recessionary Gap
G’ E’ E Y
![Page 55: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/55.jpg)
55
Expansionary Fiscal Policy Recessionary/Deflationary Gap Yf-Ye
Y-line
E = E’ + (c -ct) Y
Ye
E = E” + (c-ct) Y
-cT’
Yf
Y= k E * E’ = k T * T’
Recessionary Gap
T’ E’ by -c T’ E Y
![Page 56: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/56.jpg)
56
Contractionary Fiscal PolicyInflationary Gap Ye - Yf
Y = E
E = E’ + (c-ct) Y
YeYf
E = E” + (c-ct) Y
Nominal Y>Yf Inflationary Gap
G’
G’ E’ E Y
Y= k E * E’
![Page 57: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/57.jpg)
57
Contractionary Fiscal PolicyInflationary Gap Ye - Yf
Y = E
E = E’ + (c-ct) Y
YeYf
E = E” + (c-ct) Y
Nominal Y>Yf Inflationary Gap
-cT’
T’ E’ by -c T’ E Y
Y= k E * E’ = k T * T’
![Page 58: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/58.jpg)
58
Automatic Built-in Stabilizers
Proportional /Progressive Tax System Recession: government’s tax revenue Boom: government’s tax revenue
The more progressive the tax system, the greater is its stabilizing effect. But there will be greater dis-incentives to earn income
With t, k E With proportional tax, the multiplying effect of a discretionary change in government expenditure G’ reduces
![Page 59: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/59.jpg)
59
Automatic Built-in Stabilizers
Welfare Schemes Unemployment benefits, public
assistance allowances, agricultural support schemes Recession: government’s expenditure Boom: government’s expenditure
Again, if the welfare schemes are generous, the incentives to work will be weakened.
![Page 60: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/60.jpg)
60
Discretionary Fiscal Policy v.s.Automatic Built-in Stabilizers
If the economy is close to Yf, built-in stabilizers are useful as they can stabilize the economy around Yf or potential income level.
However, if the economy is far below Yf, discretionary fiscal policy is still necessary (Simple Keynesian model).
Another drawback of the built-in stabilizers is they may reduce the speed of recovery as
k E Y = k E * E’
![Page 61: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/61.jpg)
61
Discretionary Fiscal Policy Government expenditure G’? Tax T’? Location of effects If a recession is localized in a
particular industry G’ Tax cut will have its impact on the
entire economy
![Page 62: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/62.jpg)
62
Discretionary Fiscal Policy Government expenditure G’? Tax T’? Duration of the time lag
Decision lag : time involved to assess a situation & decide what corrective actions should be taken
Executive lag : time involved to initiate corrective policies & for their full impact to be felt
tax cut has a much shorter executive lag
![Page 63: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/63.jpg)
63
Discretionary Fiscal Policy Government expenditure G’? Tax T’? Reversibility of the fiscal policy
Government expenditure can easily be increased but are not so easy to cut as the civil servants who have vested interests in the present allocation of government expenditure will resist
Tax is easier to be changed as the civil servants who administer income tax is independent of the rate being levied. Of course, voter resistance should also be considered.
![Page 64: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/64.jpg)
64
Discretionary Fiscal Policy Government expenditure G’? Tax T’? Public reaction to short-term changes A temporary tax cut raises Yd.
Households, recognizing this situation, may not revise their current consumption. Instead, they save a large part of the tax cut.
![Page 65: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/65.jpg)
65
Financing the Government BudgetIncreasing Taxes
By increasing taxes, the government transfers purchasing power from current taxpayers to itself
Current taxpayers bear the cost If the revenue is spent on some investment
project, (current / future) taxpayers may benefit when the project is completed.
How about the revenue is spent on transfer payment?
![Page 66: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/66.jpg)
66
Financing the Government BudgetPrinting more Money
This will create inflationary pressure. Households and firms will be able to
buy less with each unit of money. Fewer resources are available for private consumption and investment.
Those whose incomes respond slowly to changes in price levels will bear most of the cost of the government activity
![Page 67: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/67.jpg)
67
Financing the Government BudgetInternal Debt
The government can transfer purchasing power from any willing lenders to itself in return for the promise to repay equivalent purchasing power plus interest in future.
Since, repayment of the debt are made from tax revenue, future taxpayers will suffer.
However, if the debt raised today is spent on creating capital assets, the burden on future generation will be lighter.
![Page 68: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/68.jpg)
68
Financing the Government BudgetExternal Debt
Borrowing from abroad transfers purchasing power from foreigners to the government.
The burden on future generations will once again depend on how the debt raised is used (investment project / transfer payment)
![Page 69: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/69.jpg)
69
The Problems of the Simple Keynesian Multiplier k E
Y = k E * G’ There are several problems with this
method of analysis, i.e., Y may be less Sources of financing G’ Effects on private investment I’ Productivity of government projects
![Page 70: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/70.jpg)
70
The Problems of the Simple Keynesian Multiplier k E
Sources of financing G’ Increasing Tax
will exert a contractionary effect on the economy Increasing Money Supply
will generate an inflationary pressure Increasing Debt
will increase the demand for loanable fund as well as interest rate affect private investment
![Page 71: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/71.jpg)
71
The Problems of the Simple Keynesian Multiplier k E
Effects on Private Investment I’ Private investment may be crowded out
when government increases its expenditure It is questionable that the government can
really produce something which is desired by the consumers
Besides, government investment projects are usually less productive than private investment projects
![Page 72: Three-sector Model (1)](https://reader036.fdocuments.in/reader036/viewer/2022062313/55cf8fa2550346703b9e3917/html5/thumbnails/72.jpg)
72
The Problems of the Simple Keynesian Multiplier k E Productivity of Government
Projects Government projects may not yield
a rate of return (MEC / MEI) exceeding the market interest rate.