A Suppose a Government Moves to Reduce a Budget Deficit

question 154

Essay

a. Suppose a government moves to reduce a budget deficit. Using the long-run model of the economy developed in Chapter 3, graphically illustrate the impact of reducing a government's budget deficit by increasing (lump-sum) taxes on household income. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction curves shift; and v. the terminal equilibrium values.
b. State in words what happens to: i. the real interest rate; ii. national saving; iii. investment; iv. consumption; and v. output.

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Definitions:

IRR

The Internal Rate of Return, a financial metric used to estimate the profitability of investments by calculating the interest rate at which the net present value of all cash flows (both positive and negative) from a project equal zero.

Investment

Allocating resources, usually money, with the expectation of generating an income or profit.

Cash Flows

The total amount of money being transferred in and out of a business, particularly in relation to liquidity.

Payback Period

The amount of time it takes to recover the cost of an investment through its cash inflows.