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ECONOMICS 11TOPIC 11

GOVERNMENT AND THE MACROECONOMY

U-PRIMO E. RODRIGUEZDept. of Econ., UPLB

THE ROAD AHEAD

Government Budget

Government and

national output:

The three-sector

model

Fiscal policy

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GOVERNMENT BUDGETGovernment budget: indicates the public sector’s expenditures and sources of incomeNet budgetary position

Budget surplus: revenues > expendituresBudget deficit: revenues < expendituresBalanced budget: revenues = expenditures

Some sources of information Philippine Statistical YearbookBureau of Treasury (www.treasury.gov.ph)Budget of Expenditures and Sources of Financing (BESF) of the Department of Budget and Management (www.dbm.gov.ph) – very detailed

Revenues & expenditures of the Phil. national government (billion Php)

Source: Bureau of Treasury (http://www.treasury.gov.ph/statdata/yearly/yr_corsum.pdf), downloaded 22 August 2013

Item 2011 2012

Revenues 1,360 1,535

Expenditures 1,558 1,778

Surplus (Deficit)

-198 -243

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Expenditures by sector of the national government (2012, % of total)

Economic services (includes agriculture, trade and natural resources) = 24%

Social services (includes health and education spending) = 34%

General public services = 18%

Defense = 5%

Debt service – interest payments = 18%

Net Lending = 1%

Source of raw data: DBM (2013) Budget of Expenditures and Sources of Funds

Expenditures by object of the national government (2012, % of total)

Personal services = 33%

Maintenance and Other Operating Expenses = 52%

Capital outlays = 14%

Net Lending = 1%

Source of raw data: DBM (2013) Budget of Expenditures and Sources of Funds

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Government Revenues 2012ITEM % share

Tax Revenues 91.5Taxes on net income and profits 43.0Taxes on property 0.2Taxes on goods and services 44.1Taxes on int’l trade & transactions 4.2

Non-Tax Revenues 8.5TOTAL 100.0

Source of raw data: DBM (2013) Budget of Expenditures and Sources of Funds

GOVERNMENT & NATIONAL OUTPUTHow do changes in government spending and taxation affect aggregate output?

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Revisions to the basic modelDisposable income (YD) - income that households are free to spend and save. YD = Y – T + Net transfers to households where: Y = income, T = taxes

Examples of transfers: unemployment benefits (other countries), conditional cash transfers (Philippines)

Aside: for convenience, let net transfers = 0. Implication: YD = Y – T

Consumption now depends on disposable income

Revised consumption function

Implies higher T leads to lower C

Revised AEAE = C + I + G

Revised equilibrium conditionY = AE = C + I + G

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Numerical example

Y T YD C I G AE1,100 100 1,000 950 100 200 1,2501,300 100 1,200 1,100 100 200 1,4001,500 100 1,400 1,250 100 200 1,5501,700 100 1,600 1,400 100 200 1,7001900 100 1,800 1,550 100 200 1,8502,100 100 2,000 1,700 100 200 2,000

Equilibrium income (Y = AE): 1,700

Y T YD C I G AE

1,100 100 1,000 950 100 200 1,250

1,300 100 1,200 1,100 100 200 1,400

1,500 100 1,400 1,250 100 200 1,550

1,700 100 1,600 1,400 100 200 1,700

1900 100 1,800 1,550 100 200 1,850

2,100 100 2,000 1,700 100 200 2,000

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Algebraic Treatment

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Graphical treatment:

Government spending and equilibrium income

Main point: G AE Y*How large is the change in income?

If

then,

G = 200

Y* = (4).(200) = 800

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Graphical treatment

Income taxes and equilibrium incomeMain point: T C AE Y*How large is the change in income?

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Graphical treatment

Balanced budget multiplierIt commonly asserted that the balanced budget multiplier is 1.

Implication: If the government raises its spending by the same amount as its taxes, then equilibrium income will increase by the same amount as the increase in government spending.

That is,

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Using the values in previous slides

Shock Impact (Y*)

G = 200 800

T = 200 -600

Total effect 200

Algebraic derivation:

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Fiscal Policy

Fiscal policy - a collective term that refers to the use of taxation and government spending to influence the level of income

Expansionary fiscal policy - spending and taxation aimed at increasing income;

e.g. , G or T

Contractionary fiscal policy - spending and taxation aimed at decreasing income;

e.g., G or T

Define: Yf = full-employment level of

output

Inflationary gap

Exists when AE >Y at Yf

There is pressure for an increase in the

general price level (inflation) because it

is not possible to produce beyond Yf.

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Can eliminate the inflationary gap through a contractionary fiscal policy

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Deflationary gap

Exists when AE < Y at Yf

There is pressure for a decrease in

output.

Implies unemployment

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Can eliminate a deflationary gap by an expansionary fiscal policy

WAKAS