Economics Homework: Macroeconomics ECON 1032 - Budget & Fiscal Policy

This document presents a comprehensive solution to a macroeconomics homework assignment (ECON 1032). The assignment addresses key concepts in fiscal policy and taxation. Question 1 analyzes the marginal and average tax rates in Waxwania, determining the nature of the tax system (proportional, progressive, or regressive) based on provided data. It also calculates the budget deficit, cyclically adjusted budget deficit, and assesses the expansionary nature of Waxwania's fiscal policy. Question 2 delves into public debt, calculating the total public debt in year 4 based on a series of budget deficits and surpluses. The solution determines public debt as a percentage of real GDP. Question 3 examines the impact of stimulus spending on investment, considering the effects of changes in real interest rates and the expected rate of return on investment. The assignment concludes by determining the extent of investment crowding out due to expansionary fiscal policy.

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Question 1
a) Marginal tax rate = Change in Tax revenue/Change in Real GDP
From the given data, it is noteworthy that when real GDP increases by $100, the tax revenue
tends to increase by $ 20. As a result marginal tax rate = (20/100) = 20%. Further, this marginal
tax rate does not alter and remains the same.
Average tax rate = Tax Revenue /Real GDP
It is noteworthy at for every combination of tax revenue and Real GDP that has been presented
for Waxwania, the tax revenue forms 20% of the Real GDP. Hence, it would be correct to
conclude that average tax rate for any level of GDP remains the same at 20%.
Since the average tax rate does not alter with real GDP and remains the same at 20%, hence it
would be correct to infer that the given tax rate system is proportional.
b) From the information provided, it is apparent that at real GDP of $ 600 million, the
government revenue in the form of tax would be $120 million while the government
expenditure would be $ 160 million.
Hence, budget deficit at $600 million GDP = $160 million - $120 million = $ 40 million
Cyclically adjusted budget deficit would be deficit that would exist at full employment real GDP
of $ 700 million. Budget deficit at $ 700 million GDP = $160 million - $140 million = $20
million
Cyclically adjusted budget deficit as a % of real GDP = ($20 million/$700 million)*100 = 2.86%
Considering that Waxwania is running a cyclically adjusted budget deficit, it would imply that
the fiscal policy pursued is expansionary.
Question 2

It is known that public debt in year 1 is zero. The information about budget deficit/surplus over
the next 4 years is summarized below.
Year 1 = $40 billion deficit
Year 2 = $20 billion deficit
Year 3 = $10 billion surplus
Year 4 = $ 2 billion deficit
Public debt essentially is the sum total of budgetary deficits and surpluses. Hence, public debt
expected in year 4 = 0 + 40 + 20- 10 + 2 = $52 billion
Real GDP (Year 4) = $104 billion
For this country, public debt as a percent of real GDP = (52/104)*100 = 50%
Question 3
If there is an increase in stimulus spending which leads to real interest rate increase by 2%, then
the investment would reduce by $ 200 billion. If this increase in stimulus spending also leads to
increase in expected rate of return on investment by 1%, then the investment is expected to
increase by $150 billion. If the two effects highlighted above are combined, it becomes apparent
that on account of expansionary fiscal policy, investment spending to the tune of $50 billion will
be crowded out.