## Question

Answer every question completely for a full grade. Please clearly show all of your work so I can appreciate how you got to a specific answer or equation. Any unexplained answer will only be judged on accuracy. This means that the correct answer will be granted full credit while the incorrect one will receive a zero. Therefore, I recommend that you show your work. Make sure to draw your graphs clearly indicating the title of each axis.

The graphs are estimates. The most important thing is that you show the equilibrium point both on the P axis and the Y axis and how graphs shift in case of policy implementation.

1- Assume an economy with the following variables:

YN = 12,500; t = 16% ; YA = 11,500; G = 5000 ; Ta = 975

a) Compute the amount of taxes at natural GDP.

b) Compute the amount of taxes at real GDP

c) Compute the actual deficit and express it as percent of actual GDP

d) Compute the N.E.D (Natural Employment Deficit and express it as a percent of natural GDP.

2- Assume an economy with the following variables:

YN = 18,500; t = 23% ; YA = 16,650; G = 6,500 ; Ta = 700.

a) Compute the amount of taxes at actual GDP and express it as a percent of actual GDP.

b) Compute the amount of taxes at natural GDP and express it as a percent of natural GDP.

c) Policymakers decide to reduce the actual deficit to 6% of the natural GDP. What will be the size of the actual deficit under these conditions?

d) Given no change in the tax rate t, compute by how much they should cut G to accomplish their goal in question c.

e) Given no change in G, what should be the tax rate in order to accomplish the policy goal in question c.

f) Suppose you are asked to make a policy recommendation that requires you to increase the tax rate (from 23%) and decrease government spending. What combination of tax rate and spending cut would you recommend to meet the policymakersâ€™ goals in question c? Answers may vary.

3- Consider the following economy with Ta = 875 and YA = 10000

a) If G = 3,950, Derive the equation of the actual budget deficit BDA as a function of t (tax rate).

b) Find the tax rate at which the country will be running a budget balance.

c) Find the values of the deficits for the following tax rates: 10%, 16%, 24%, 32%, 31%, 32% 36% and 40%, 44% and 50%.

d) Graph your findings in c using any graphing tool.

4- Consider the following economy with Ta = 975 and YA = 10,000.

a) If t is constant at 14%, derive the equation of the BDA as a function of G.

b) Find the value of G for which the country will be running a budget balance.

Budget Balance BD = 0.

c) Find the values of the deficits for the following G spending levels: 10,000, 9000, 7,000, 5,000, 4,000, 3,000, 2,000, 1000 and 0

d) Graph your findings in c using any graphing tool.

## Solution Preview

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1. a) Tax at natural GDP (T) = 0.16*12500 = 2000b) Tax at real GDP = 0.16*11500 = 1840

c) 5000-1840=3160 Deficit as % of actual GDP = (3160/11500)*100 = 27.48%...

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