Ecs2602 Exam Study Pack 2022

ECS2602 EXAM STUDY PACK 2022. ECS2602 - Macroeconomics In the goods market model a decrease in taxes will result in … a) an increase in autonomous consumption. b) an increase in disposable income. c) an increase in income. d) a decrease in induced consumption. 1) a, b and c 2) a, b and d 3) b, c and d 4) a, c and d 5) None of the options 1 to 4 (correct option is 5.) Explanation A decrease in taxes increases disposable income and consequently induced consumption spending increases. As consumption spending increases producers increase production and consequently income increases. The multiplier effect is in operation. A decrease in taxes does not impact on autonomous consumption. Only alternatives b and c are correct and therefore the correct option is 5. Question 5 Which of the following are correct in terms of the goods market model? a) G↑ → Z↑ → Y↑ → YD↑ → C↑ b) I↑ → Z↑ → Y↑ → YD↑ → C↑ c) T↓ → Z↑ → Y↑ → YD↑ → C↑ d) c0↑ → Z↑ → Y↑ → YD↑ → C↑ 1) Only a, b and c 2) Only a, b and d (The correct option is therefore 2.) 3) Only b, c and d 4) Only a, c and d 5) a, b, c and d Explanation 3 All the chain of events except c is correct. For c to be correct is should have been as follows: T↓ → YD↑ → C↑ → Z↑ → Y↑ Question 6 Which of the following is/are correct in terms of the goods market model? a) Autonomous consumption is represented by c0 + Ī + G – cT. b) Induced consumption is presented by cYD. c) The demand for goods determines the amount of goods that producers produce and they will only change their production if the demand for goods changes. d) Equilibrium is presented by Y = c0 + c(Y−T) + Ī + G. 1) a, b, c and d 2) Only a, b and d 3) Only a, c and d 4) Only a, b and c 5) Only b, c and d (The correct option is therefore 5.) Explanation All the statements except statement a is correct. Autonomous consumption is only c0. Questions 7 to 13 are based on the following data for the country PORTHOS for 2011. Marginal propensity to consume = 0.5 Autonomous consumption = R600 million Investment = R40 million Government spending = R280 million Taxes = R30 0 million Question 7 Which of the following statements is/are correct? a) The value of the multiplier is equal to 2. b) The budget surplus is R20 million. c) The equilibrium level of output and income is R1 540 million. d) Total consumption is R1 220 million. 1) Only a, b and c 2) Only a, b and d 3) Only b, c and d 4) Only a, c and d 5) a, b, c and d (correct option is 5.) Explanation To answer this question correctly you must do the following: Calculate the multiplier. The formula for the multiplier is 1/1-c. Given a marginal propensity to consume of 0.5 the value of the multiplier is 2. Calculate the equilibrium level of output and income. The formula for the equilibrium level of output and income is ( ̅ ) 4 Given the information in the question the equilibrium level of income is 2 x (600 million + 40 million + 280 million – 0.5(300 million)) = 2 x R770 million = R1 540 million. Note that you must subtract cT. Calculate the budget balance. The budget of government is the difference between tax revenue and government spending (T – G) or (G – T). In this case there is a budget surplus of R20 million since T = R300 million and G = R280 million. Calculate consumption spending at the equilibrium level of output and income. The consumption spending in this model is C = co + cYD. Given a value of R600 million for c0 and YD = Y – T = (R1540 million – R300 million) = R1 240 million, consumption spending at the equilibrium level of income = 600 + 0.5(1 240) = R600 million + R620 million = R1 220 million. All the statements are correct and therefore the correct option is 5. Question 8 An economist Dr B right Spa k calculated that the gap between the current level of output and income and the full employment level of income is R110 million. Which of the following will en sure that full employment is re ached? a) An increase in government spending of R8 0 million which will result in a budget deficit of R10 million. b) A decrease i n taxation of R160 million which will result in a bud get deficit of R90 million. c) An increase in government spending of R4 0 million and a decrease in taxation of R80 million which will result in a budget deficit o R50 million. 1) a, b and c 2) Only a and b 3) Only a and c 4) Only b and c 5) None of the options 1 t o 4 (correct option is 5.) Explanation The following diagram shows the economy of PORTHOS. The vertical intercept is 770: c0 + Ī + G – cT = 600 + 40 + 280 – 0.5(300) = R920 million – R150 million = R770 million. The equilibrium level of income is R1 540 million and the level of full employment R1 650 million, that is R1540 million + R110 million (the output and income gap). 5 In this particular model one way of reaching full employment is to increase autonomous spending. The increase in autonomous spending that is required is equal to 110 million/2 = R55 million. Remember a multiplier of 2 indicates that for every R1 increase output and income increases with R2. If government spending is to be used it implies that government spending must increase with R55 million. This will increase autonomous spending with R55 million. In this case the budget surplus of government changes from R20 million to a budget deficit of R35 million. Tax revenue is still R300 million but government spending is now R280 million + R55 million = R335 million. Thus T – G = R300 million – R335 million = –R35 million. If taxation is to be used to get an increase of R55 million in autonomous spending it implies that the decrease in taxes should be R110 million. The reason why taxes should be decreased by R110 million is due to the fact that households increase their spending not by the full amount of the decrease in tax but only by c(T). In other words, c(T) must be equal to R55 million. It therefore follows that T = R55 million/0.5 = R110 million. In this case the budget surplus of R20 million changes into a deficit of R90 million. Tax revenue decreases to R300 million – R110 million = R190 million while government spending is R280 million. An increase in government spending of R80 million will take the economy beyond full employment while the budget deficit increases to R60 million. [T – G = 300 – (280 + 80) = 300 – 360 = –R60 million]. A decrease in taxation of R160 million will take the economy beyond full employment while the budget deficit increases to R140 million. [T – G = (300 – 160) – 280 = 140 – 280 = –R140 million]. An increase in government spending of R40 million increases output and income by 2 x 40 million = R80 million while a decrease in taxes of R80 million increases output by 0.5(R80 million) x 2 = 40 x 2 = R80 million. The net change in output and income is therefore R80 million + R80 million = R160 million. The impact on the budget of government is that the budget surplus of R20 million (see question 7) changes into a deficit of 100. [T – G = (300 – 80) – (280 + 40) = 220 – 320 = –R100 million]. None of these statements are therefore correct and the correct option is 5. Question 9 The President of the country Mr Cold Water is not interested in full employment. He is only interested to win the general elections during the current fiscal year and decide d to cut taxes with R1 50 million. By how much will the level of output and income increases if taxes are cut by R150 million? 1) R150 million. (The correct alternative is therefore 1.) 2) R300 million. 3) R75 million. 4) R50 million Explanation If taxes are cut by R150 million the output and income increases by c(T) x the multiplier = 0.5(150 million) x 2 = R75 x 2 =R150 million. Question 10 Mr Cold Water then realised that the country cannot afford an increase in the budget deficit due to its inability to raise loans to finance the budget deficit. He decided to keep the tax cuts at a R150 million and a budget surplus of R20 million. To ensure a budget surplus of R20 million the government will have to ... 1) cut government spending with R80 million. 2) cut government spending with R75 million. 3) cut government spending with R150 million. (The correct alternative is therefore 3.) 4) increase government spending by R100 million. 6 Explanation To ensure that the budget surplus is unchanged at R20 million government spending must decrease by R150 million to compensate for the decrease of R150 million in tax revenue. Taxes is now R300 million – R150 million = R150 million. To keep the budget surplus unchanged at R20 million (as calculated in question 7) government spending must be equal to R130 million because T – G = R150 million – R130 million = R20 million. Government spending must therefore decreased by R150 million since R280 million – R150 million = R130 million. Question 11 The end result of the actions by Mr Cold Water is that the level of output and income will … 1) increase by R150 million. 2) increase by R300 million 3) be unchanged. 4) decrease by R150 million. (The correct option is therefore 4.) 5) decrease by R300 million. Explanation To be able to answer this question you must understand the balanced budget multiplier. The balanced budget multiplier indicates that an equal change in government spending and taxes, while leaving the budget unchanged, still have an impact on the level of output and income. In the case of an equal increase in government spending and taxes it will have a stimulatory impact on the level of output and income while for an equal decrease in government spending and taxation it will have a contractionary impact. In this case study taxes decreased by R150 million (given in question 9) while government spending also decreased by a R150 million (calculated in question 10). The end result is that the economy contracts with R150 million. The reasoning for this as follows: The impact of a decrease in taxation: When dealing with taxation you have to remember that, unlike government spending, taxation influence the demand indirectly through the consumption function (which captures the behaviour of households). According to this function households will increase their consumption spending as their income increase but the increase in consumption is less than the increase in income. This effect is captured by the marginal propensity to consume. Therefore, in this model the decrease in taxation of R150 million causes an increase in disposable income (YD) of R150 million. This increase in disposable income causes consumption spending to increase not by R150 million but by c x YD = 0.5 x R150 million = R75 million. So, the injection in the economic system is R75 million and it is from this basis that the multiplier operates. The increase in output and income is therefore equal to the multiplier x c(T) = 2 x 0.5(150) = 2 x 75 = R150 million. The decrease in government spending of a R150 million causes autonomous spending (this is the leakage) to decrease by R150 million. It is from this basis that the multiplier starts to operate and the decrease in output and income is equal to the multiplier times the change in government spending = multiplier x G = 2 x R150 million = R300 million. Thus, the decrease in taxes leads to an increase of R150 million in the level of output and income while the decrease in government spending leads to a decrease of R300 million in the level of output and income. The end result is therefore: Increase in income due to the decrease in taxes – decrease in income due to decrease in government spending = R150 million – R300 million = –R150 million. Note: In your goods market diagram the demand for goods curve shifts upwards with 75 million and then downwards with 150 million leading to a lower level of income and output. 7 The correct option is therefore 4. Question 12 After these actions the gap between the equilibrium level of output and income and the full employment level of income (as calculated by Dr Bright Spark) will be … 1. R280 million. 2. R110 million. 3. R0. 4. R260 million. (The correct option is therefore 4.) Explanation To answer this question you must first calculate the equilibrium level of income after the policy actions that consist of the decrease in taxation of R150 million and a decrease in government spending of R150 million. One way of doing it is as follows: ( ( )) ( ) Remember G = R130 million (calculated in question 10). The gap between full employment and the current level of output and income is: R1 650 million – R1 390 million = R260 million. The economy is now further away from full employment. The correct option is therefore 4. Question 13 Mr Cold Water … 1) lost the election because unemployment has increased. 2) won the election because taxpayers were better off. 3) won the election because the level of output and income has increased. 4) winning or losing has nothing to do with the economy Explanation Whether Mister Cold Water wins or lose the election depends on whether the voters care about the economy when choosing their government. If they care about the economy it then depends on how well informed they are about the impact of the actions of Mr Cold Water. If they have a very short time horizon they will only consider the impact of the decrease in the tax rate. The decrease in the tax rate has an immediate impact on their disposable income while the decrease in government spending will probably only take effect after the election. A rational voter will however take this into account and will not be fooled by Mister Cold Water. There is therefore no correct answer and the question was not marked. Question 14 If an increase in the budget deficit is unacceptable in a country where the marginal propensity to consume is 0.8, which of the following policy actions will increase the level of output and income without increasing the budget deficit? a) An increase in government spending of R10 million and an increase in taxation of R10 million. b) An increase in government spending of R20 million and an increase taxation of R20 million. c) An increase in government spending of R40 million and an increase in taxation of R40 million