Suppose that in 2002, Australia’s GDP was at potential and the government was running a balanced budget. If a slump began and the government changed no laws or policies, what impact would this have on the budget balance?

Question 1

Suppose that in 2002, Australia’s GDP was at potential and the government was running a balanced budget. If a slump began and the government changed no laws or policies,

  • how would this affect government purchases, transfer payments and tax collected (if at all)?
  • what impact would this have on the budget balance?
  • what impact would the changes in part a) have on real GDP (compared to if they didn’t occur)?
  • give some examples of counter-cyclical fiscal policy that might be an appropriate response?

Question 2

The right remedy for the [business] cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom. – John Maynard Keynes

  1. Suppose a government decided to conduct fiscal policy to keep the rate of unemployment below the natural rate. Using the AD-AS model, predict the likely outcomes of this policy.
  2. Do you think this policy is sustainable?

Question 3

Suppose the GDP in Stiglitzland was equal to potential GDP and a sudden change in international consumer tastes caused an increase in its autonomous exports of $10bn. The MPC is equal to 0.75.

  1. Using the AD-AS model to illustrate and explain, what is the short run and long run impact of this shift?
  2. If the government of Stiglitzland is committed to keeping prices steady, how could they do this by altering lump-sum taxes? How much would they need to increase or decrease lump sum taxes by to achieve this goal?

Question 4

GDP initially equals $980bn while potential GDP equals $1000bn. The government intends to use government purchases to bring GDP to its potential level. Given this information and using the AD-AS model to explain, is the following statement true or false?

“The government’s action will be ineffective in the long run because the government purchases multiplier is zero in the long run”

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