# (1) A reduction in the lump sum tax (2) A rise in the marginal propensity to import (3) A decrease in the marginal propensity to consume

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1 S.7 Economics On 3 & 4-Sector Simple Keynesian Models S.7 Economics/3 & 4-sector Keynesian Models/p.1 95 #4 Which of the following would reduce the multiplier effect of investment on national income? (1) A reduction in the lump sum tax (2) A rise in the marginal propensity to import (3) A decrease in the marginal propensity to consume A (1) and (2) only B (1) and (3) only C (2) and (3) only D (1), (2) and (3) 96 #1 Consider the following model: C = Yd I = Y T = 0.1Y G = 10 C = consumption Yd = disposable income Y = income I = investment T = tax The government expenditure multiplier is A 1.66 B 2.17 C 3.85 D #4 What will be the result of a fall in the marginal propensity to consume? (1) A smaller government expenditure multiplier (2) A concretionary effect on the economy (3) A fall in the government tax revenue under a proportional tax system A (1) and (2) only B (1) and (3) only C (2) and (3) only D (1), (2) and (3) 97 #4 Suppose a government reduces its expenditure on goods and services and at the same time increases its transfer payments to the public by the same amount, then A The government expenditure multiplier would become smaller. B Aggregate expenditure would remain unchanged. C National income would decrease. D National income would increase with a government expenditure multiplier of 1.

2 S.7 Economics/3 & 4-sector Keynesian Models/p.2 97 #5 Consumption A B D E Consumption 45 o 0 F G H In the above diagram, the marginal propensity to save is equal to Income A BD/GH B DE/GH C BD/OH D BE/OH 97 #19 Study the following information of an economy: C = Yd Where C = consumption expenditure I = Yd Yd = disposable income T = 100 I = investment expenditure G = 100 The income of the economy will increase by 100 if the government expenditure increases by A 25 B 40 C 60 D #2 Suppose the marginal propensity to consume is under a lump sum tax system, how much tax decrease would have the same effect on the equilibrium income as a \$45 million increase in government spending? A \$25 million B \$60 million C \$120 million D \$180 million 98 #4 Refer to the following diagram of an open economy without the government

3 sector. \$ S.7 Economics/3 & 4-sector Keynesian Models/p.3 S + M C + I I + X 0 45 o A B Income Which of the following statements about the economy are true? (1) The equilibrium income is OA (2) The equilibrium income is OB (3) The economy has a trade surplus (4) The economy has a trade deficit A (1) and (3) only B (1) and (4) only C (2) and (3) only D (2) and (4) only 98 #25 If the government adopts a proportional income tax, the aggregate expenditure curve will become and the investment multiplier will become. A flatter... smaller B steeper... smaller C flatter...larger D steeper...larger 99 #1 The diagram below shows the aggregate expenditure in a closed economy without taxes. At the equilibrium income level, the average propensity to save is given by the ratio

4 S.7 Economics/3 & 4-sector Keynesian Models/p.4 Expenditure S C + I + G 0 A PQ / OR B QR / OU C ST / OU D SU / OU P Q R T 45 o I + G U Income 99 #5 In the elementary Keynesian model, fluctuations in investment will induce.. fluctuations in income under the proportional tax system.. under the lump sum tax system. A more... than B less... than C the same amount of... as D no... or 99 #22 In an economy, suppose the government budget is in balance while the trade account is in deficit. We can conclude that A The sum of government spending and exports is greater than the sum of taxation and imports. B The sum of investment spending and exports is greater than the sum of savings and imports. C The sum of government spending and investment spending is greater than the sum of taxation and savings. D None of the above. 00 #4 Which of the following would offset the effect of an increase in the marginal propensity to consume on the value of the government expenditure multiplier? (1) An increase in the marginal propensity to import (2) An increase in the marginal propensity to invest (3) An increase in the proportional income tax rate A (1) and (2) only

5 B (1) and (3) only C (2) and (3) only D (1), (2) and (3) S.7 Economics/3 & 4-sector Keynesian Models/p.5 00 #6 Consider the following model: C = Yd Where C = consumption expenditure I = 200 Y = national income G = 500 Yd = disposable income T = Y I = investment expenditure T = tax At equilibrium, the government budget surplus is and the government expenditure multiplier is A negative B negative C zero D positive #20 Which of the following can raise the employment level of an economy? (1) Export promotion (2) Increase in foreign investment in the economy (3) Reduction in the income tax rate A (1) and (2) only B (1) and (3) only C (2) and (3) only D (1), (2) and (3) 01 #1 Consider the following diagram of a closed economy:

6 E S.7 Economics/3 & 4-sector Keynesian Models/p.6 E = Y E = C + I + G Which of the following is true at the equilibrium income level? A Investment is greater than saving. B Investment is equal to saving. C Investment is smaller than saving. D The answer is indeterminate. T - G Y E = expenditure Y = income C = consumption I = investment G = government expenditure T = tax 01 #2 Which of the following will reduce the size of the government expenditure multiplier? (1) An increase in the proportional income tax rate (2) A decrease in the marginal propensity to invest (3) A decrease in the marginal propensity to save A (1) and (2) only B (1) and (3) only C (2) and (3) only D (1), (2) and (3) 01 #29 Consider the elementary Keynesian model with a lump sum tax but without foreign trade. Suppose the equilibrium income is \$5000 and the full employment income is \$600. if full employment can be achieved by a \$50 increase in government spending, then what decrease in lump sum tax is needed in order to achieve full employment? A \$25 B \$50 C \$75 D \$ #3 Refer to the following diagram of an open economy without the government section.

7 S.7 Economics/3 & 4-sector Keynesian Models/p.7 C = consumption I = investment 45 o line X = exports M = imports C + I 0 Y 1 Income X - M Which of the following statements is/are true? (1) At Y 1, saving is larger than investment. (2) The equilibrium level of income is smaller than Y 1. (3) There is a trade surplus at equilibrium income. A (1) only B (1) and (2) only C (2) and (3) only D (1), (2) and (3) 02 #4 Consider the following model. C = Yd where C = consumption expenditure I = Y Yd = disposable income G = 300 I = investment expenditure T = 30 Yf =5080 T = tax Y = national income Yf= full employment national income In order to attain the level of full employment national income, what is the required change in the lump-sum tax? A -8 B -10 C 8 D #2 Refer to the following closed economy C = Yd Where C = consumption expenditure I = 100 Yd = disposable income

8 G = 200 T = 0.4 Y S.7 Economics/3 & 4-sector Keynesian Models/p.8 I = investment expenditure T = tax Y = national income The expenditure multiplier is A 1.67 B 1.92 C 2.08 D 5 03 #4 Which of the following cases will exert and expansionary effect on the economy when there is an equal increase in government expenditure and tax? (1) There is proportional tax and no marginal propensity to invest. (2) There is proportional tax and positive marginal propensity to invest. (3) there is no proportional tax, but positive marginal propensity to invest. (4) There is no proportional tax and no marginal propensity to invest. A (1) and (2) only B (1) and (4) only C (2) and (3) only D (1), (2), (3) and (4) 03 #10 Define private saving as SP = Y T C, public saving as SG = T G and national saving as the sum of private and public saving. Y, T, C and G are national income, tax, consumption expenditure and government expenditure, respectively. It follows that, in an open economy, A Private saving is equal to domestic investment. B National saving is equal to domestic investment. C Private saving is equal to the sum of domestic investment and net exports. D National saving is equal to the sum of domestic investment and net exports. 03 #26 Which of the following can explain the co-existence of unemployment, budget deficit and trade deficit? A A fall in consumption expenditure B A fall in investment expenditure C A fall in exports D A fall in government expenditure 04 #5 In a closed economy, the balanced budget multiplier is smaller than one when A There is no induced consumption in the economy. B The marginal propensity to invest is greater than zero. C The marginal propensity to consume falls by 10%.

9 D None of the above. S.7 Economics/3 & 4-sector Keynesian Models/p.9 04 #6 Refer to the following diagram of a closed economy. Expenditure 45 o Line C - I C = consumption expenditure I = investment expenditure T = tax S = saving T - G 0 National income Y 1 Which of the following statements about the economy is correct? A At Y 1, the level of foreign exchange reserves must remain constant. B At Y 1, the budget surplus is zero. C At Y 1, the value of injection (I+G) is equal to the value of withdrawal (S+T). D At Y 1, there will be an increase in inventory. 04 #8 Refer to the following diagram of a closed economy. E E = Y E = C + I + G T - G Y = national income E = aggregate expenditure C = consumption expenditure I = investment expenditure T = tax Y e = initial equilibrium income Y f = full employment income 0 Y e Y f Y Full employment and budget balance can be attained simultaneously when A There is an increase in autonomous investment. B There is an increase in autonomous government expenditure. C There is a reduction in both lump sum tax and government expenditure by the same amount.

10 S.7 Economics/3 & 4-sector Keynesian Models/p.10 D There is a reduction in lump sum tax. 04 #10 Refer to the following diagram of an open economy. E 45 o E M X T - G Y = national income E = aggregate expenditure M = imports X = exports T = tax Y f = full employment income 0 Y f Y Y f is the initial equilibrium income in the economy. Which of the following changes could generate unemployment, trade deficits, and fiscal deficits simultaneously? A A fall in private consumption B A fall in exports C A rise in private consumption D A rise in exports 05 #1 In an open economy, national saving need not equal real investment. When national saving exceeds real investment, it means that A There are net exports to the rest of the world. B There is foreign investment in the form of real investment in the rest of the world. C There is foreign investment in the form of financial investment in the rest of the world. D All of the above. 05 #4 In a closed economy with the government sector, consumption rises by \$60 when disposable income rises by \$100. Which of the following about the economy must be true. (1) The marginal propensity to save is 0.4. (2) The average propensity to consume is 0.6 (3) When investment increase by \$20, the maximum possible increase in national income is \$50. A (1) only B (1) and (2) only

11 C (1) and (3) only D (2) and (3) only S.7 Economics/3 & 4-sector Keynesian Models/p #5 Which of the following will reduce the expansionary effect of an increase in government expenditure in the elementary Keynesian model? A An increase in lump sum tax. B A decrease in the marginal propensity to save. C A decrease in the marginal propensity to import. D All of the above. 05 #6 Use the following information about an economy to answer Question 6 to 8. C = Y d where C = consumption expenditure I = 110 Y d = disposable income G = 200 I = investment expenditure T = τy G = Government expenditure NX = Y d T = taxes Y d = Y T τ = proportional income tax Y = national income NX = net exports Suppose the governments objective is to balance its budget, the equilibrium level of income will be A B C D #7 With the same government objective, the equilibrium tax rate is A 0.08 B 0.11 C 0.14 D 0.16

12 S.7 Economics/3 & 4-sector Keynesian Models/p.12 06#1 Refer to the following diagram of an open economy with no government sector. At the equilibrium income level, planned saving is planned investment and the economy has a trade. A greater that deficit B smaller than deficit C equal to surplus D greater than surplus 06#3 The above diagram shows an elementary Keynesian model for a closed economy. In this economy, all taxes are in lump sum fashion and investment is autonomous. The aggregate expenditure function shifts upward from E1 to E2 as a result of a change in lump sum tax. The change in lump sum tax is. A 50 B 62.5 C -50 D -62.5

13 S.7 Economics/3 & 4-sector Keynesian Models/p.13 06#4 In a closed economy, national saving is \$1 000 and price saving is \$750. This means that the government has a and the equilibrium level of investment is. A budget deficit of \$250 \$250 B budget deficit of \$100 \$1000 C budget surplus of \$250 \$1000 D budget surplus of \$200 \$ #B1 Consider the elementary Keynesian model. (a) Explain how an increase in the lump sum tax affects income. (4) (b) Suppose the tax multiplier of the lump sum tax is -4. By how much will income change if the government expenditure increases by 100? (4) 95 #C7 In an elementary Keynesian model, there is a proportional income tax and government expenditure just equals its tax revenue. (a) Explain the impact of an increase in investment on income, the government budget balance and the external trade balance. (6) (b) Suppose now the government is required to balance its budget. Explain whether the impact of an increase in investment on income will be larger or smaller than that in (a). (4) 96 #B1 Consider an elementary Keynesian model without a government sector. Explain whether planned saving can exceed, equal, or fall short of planned investment at equilibrium in an open economy. How about in a closed economy with government sector? How about in a open economy? 96 #B4 Consider a country with unemployment. With the aid of a diagram, explain how an equal increase in government expenditure and lump sum tax affects the income of the country. Show that the balanced budget multiplier is one. 97 #B1 Consider an elementary Keynesian model with proportional income tax and unemployment. Suppose the government budget is in deficit. Show how a \$1 increase in government expenditure affects (a) National income. (4) (b) Government budget deficit. (4) 97 #B4 The following table gives the composition of Country A s GNP: Consumption Investment Government expenditure GNP 145 X

14 S.7 Economics/3 & 4-sector Keynesian Models/p.14 (a) (i) Find the value of X. Is the value a realized investment or a planned investment? (ii) Explain whether the value you calculated in (a) (i) can be planned investment as well as realized investment. (4) (b) Suppose the planned investment is 30. Explain how Country A s GNP will change. (4) 97 #C7 Consider the following economic model: C = Y I = 10 G = 10 X = 70 M = Y C = consumption expenditure Y = income I = investment expenditure X = exports M = imports (a) Find the equilibrium level of income and the corresponding trade balance. Illustrate your answers with a diagram. (6) (b) Supposing exports increase by one unit, explain the impact of this on income and trade balance. (4) 99 #C7 Consider an unfunded social security system in a closed economy with unemployment. The system involves a redistribution of income from young people to old people, i.e., the young is taxed and the tax proceeds are distributed to the old as transfer payments. There are 400 young people and 100 old people in the population. All the old people have retired and their pre-transfer income is zero. The consumption functions and disposable incomes of these two groups of people are given as follows: C1 = yd1 Where C1 = consumption of each young person C2 = yd2 C2 = consumption of each old person yd1 = y1 t yd1 = disposable income of each young person yd1 = tr yd2 = disposable income of each old person y1 = pre-tax income of each young person t = taxes paid by each young person tr = transfer payments received by each old person (a) Give one reason why the marginal propensity to consume of the old may be higher than that of the young. (3) (b) Suppose the social security tax is the only tax in the economy and there is no government spending. Suppose further that these taxes and transfers are lump sums. (i) Use the balanced budget condition to find tr given t = 100. (2)

15 S.7 Economics/3 & 4-sector Keynesian Models/p.15 (ii) Based on your answer to (b) (i), find the aggregate consumption, C, (i.e., sum of consumption over both the young and old people) as a function of y1. Then, divide this (pseudo) aggregate consumption function by the total population to obtain per capita consumption, c. Find c as a function of y1. (3) (iii) Suppose there is no such social security system in the economy. Find c as a function of y1. (2) (c) Use the elementary closed economy Keynesian model with no investment to explain the effect of the above social security system on the aggregate consumption, aggregate output, and aggregate saving of the economy. (4) 00 #B1 Consider an elementary closed Keynesian model. The only tax in the model is a lump sum tax. (a) Suppose both government expenditure and tax increase by the same amount. Explain the impact of such changes on the equilibrium level of income. (4) (b) Suppose government expenditure increase by an amount smaller than the increase in tax. Explain the impact of such changes on the equilibrium level of income. Under what condition will be impact be zero? (4) 00 #B5 Consider an elementary Keynesian model with a trade deficit. (a) Indicate on a diagram the equilibrium level of income and the trade deficit. (3) (b) With the aid of the diagram in (a), explain how an increase in investment affects equilibrium income and trade deficit. (5) 01 #C6 Consider the following economy. C = Yd I = 100 G = 200 T = 0.2 Y C = consumption Yd = disposable income I = investment T = tax Y = income (a) Find the government expenditure multiplier, the equilibrium income and the government budget balance. (6) (b) Suppose investment decreases (i) Explain the impact on equilibrium income and the government budget balance. (4) (ii) Suppose the government adjusts the tax rate to balance its budget. Explain whether the equilibrium income under this situation will be higher

16 S.7 Economics/3 & 4-sector Keynesian Models/p.16 or lower than that in (i). (3) 02 #B4 The national income accounting equation states that Y = C + I + G + NX, where Y, C, I, G, and NX stand for national income, consumption, investment, government expenditure, and net exports (i.e., difference between exports and imports) respectively. (a) Define private saving as S P = Y T C and public saving (or fiscal budget surplus) as S G = T G, where T stands for the government s tax revenue. Show that there is a one-to-one correspondence between fiscal deficits and trade deficits when S P = I. (2) (b) Define national saving as the sum of private and public savings so that S = S P + S G. Show that S I = NX. It follows that, in the open economy, national saving is not necessarily equal to domestic investment. Explain why if a country is running a current account deficit, its national saving MUST be insufficient to finance domestic investment. Explain also why the excess of its investment over and above its saving would show up as its capital account surplus. (5) (c) Does it follow that national saving is always equal to investment in a closed economy? If not, when will they be equal to each other? (3) 02 #C6 Answer the following questions with the aid of the elementary Keynesian model. Suppose the Hong Kong economy was initially in full employment with a fiscal budget balance and a trade balance. The economy is currently suffering from problems of unemployment and the twin deficits (i.e., the coexistence of trade deficits and fiscal budget deficits). (a) Three explanations, all of which involve a reduction in autonomous spending, have been proposed: (i) a fall in private consumption, (ii) a fall in private investment, (iii) a fall in exports. Evaluate the ability of each of these factors to explain the coexistence of unemployment and the twin deficits. (6) (b) As a fourth possibility, is a fall in government expenditure a valid explanation for these three problems? To balance its budget, the government has to find ways to increase its revenue and/or cut its expenditure. Will such fiscal actions help resolve the unemployment and trade deficits problems simultaneously? If not, how will unemployment and trade deficits be affected by such actions? (4) 03 #C7 The Hong Kong government is very much concerned with the problem of budget deficits. One measure the government has adopted is to cut its spending by reducing the salaries of the civil servants. In principle, the government could also raise the salary tax to achieve similar results. Another measure the government is contemplating is to increase its revenue by introducing a sales tax. The following questions try to compare the revenue-raising effects and other economic effects between an income tax and a consumption tax using a simple Keynesian model. Suppose the consumption function takes the form C = Y d, where Y d = Y T, Y is national income and T is tax. In the case of income tax, T = 0.25 Y; whereas in the case of a consumption tax, T = 0.25C, where proportional

17 S.7 Economics/3 & 4-sector Keynesian Models/p.17 tax rates on income and consumption are both 25%. For simplicity, suppose the economy is closed with no investment, but there is a positive level of government expenditure G = 120. in equilibrium, Y = C + G. (a) In the case of an income tax, find the equilibrium level of income. How much revenue can the government raise? (3) (b) In the case of a consumption tax, find the equilibrium level of consumption. How much revenue can the government raise? [Hint: You should first show that the consumption function satisfies C = 25 + (2/3)Y.] (5) (c) Based on your answers to (a) and (b), compare revenue-raising as well as other effects on the economy of the two kinds of taxes. (4) (d) If you have answered (c) correctly, you will have found that (at the same tax rate) the consumption tax cannot generate as much tax revenue as the income tax. Can you describe some advantage of taxing consumption in practice? (2) 04 #C5 Consider the following elementary Keynesian model: C = Yd Yd = Y T I = 110 G = 100 NX = Yd T = Y Where C, Yd, Y, T, I, G, NX and stand for consumption expenditure, disposable (or after-tax) income, gross(pre-tax) income, taxes, investment expenditure, government expenditure, net exports, and the (proportional) income tax rate respectively. (a) Suppose the government s objective is to balance its budget(i.e., make T=G) (i) What is the equilibrium income tax rate( *) it has to choose to achieve the objective? At that particular tax rate, what is the equilibrium level of income(y*)? (ii) Will the equilibrium trade balance (NX*) be in surplus or deficit? (5) (b) Suppose instead that the government s objective is to balance trade(i.e., make NX=0) (i) What is the equilibrium income tax rate( *) it has to choose to achieve this other objective? At that particular tax rate, what is the equilibrium level of income? (Y*)? (ii) Will the equilibrium fiscal budget (i.e.,t* -G) be in surplus or deficit? (5) (c) Based on your answer to (a) and (b) above, is there a tradeoff between the trade

18 S.7 Economics/3 & 4-sector Keynesian Models/p.18 balance and the fiscal balance? In the context of this example, when do you think trade deficits and budget deficits(i.e., twin deficits ) may coexist? (4) 05 #B2 (a) State the paradox of thrift. (2) (b) In the context of a closed-economy elementary Keynesian model without the government sector, explain how an increase in desired( private) saving will affect the equilibrium level of the following: national saving, investment, and national income. Does the paradox of thrift hold in this case? (4) (c) In the context of a closed-economy elementary Keynesian model with the government, explain how an increase in public saving will affect the equilibrium level of the following: national saving, investment, and national income. Does the paradox of thrift hold in this case? (4) 05 #B3 Consider the following elementary Keynesian model for a closed economy without investment: C= C +(mpc) Y d, with C >0 and 0< mpc<1, Y d =Y-T, T= T >0, under pure lump-sum tax(i.e.,τ=0), G= G >0, τy, with 0<r<1, under pure income tax(i.e.,t =0), Where C, mpc, Y d, Y,T, T, and G stand for consumption, expenditure, marginal propensity to consume, disposable ( or after-tax) income, gross(pre-tax) income, taxes, the lump-sum tax, the(proportional) income tax rate, and government expenditure respectively. C and G are constant. (a) Find the equilibrium level of income (i) In terms of (mpc, C,T, G ) under the pure lump-sum tax policy. (ii) In terms of (mpc, C,τ, G ) under the pure income tax policy. (2) (b) Under balanced budget, T = G under the pure lump-sum tax policy. Use this condition to find (i) The equilibrium level of income in terms of (mpc, C, G ) and (ii) The balanced-budget multiplier. (3) (c) Under balanced budget, τy=g under the pure income tax policy. Therefore, the tax rate is given by τ= G /Y. Use this condition to find (i) The equilibrium level of income in terms of (mpc, C, G ) and

19 S.7 Economics/3 & 4-sector Keynesian Models/p.19 (ii) The balanced-budget multiplier. (3) (d) Compare the answers to part (b) and (c) above. Does your comparison depend on the assumption of zero investment? (2) 06 #B6 (a) An example of expenditure-reducing policies is to increase income taxes. (i) (ii) Explain without using any graphs and economic models why raising the income tax rate can help improve the trade balance. (2 marks) Using the elementary Keynesian model, explain the effects of such a policy on equilibrium income, consumption, national saving, and the trade balance. (4 marks) (b) An example of expenditure-switching policies is to provide export subsidies. (i) (ii) Explain without using any graphs and economic models why providing export subsidies may help improve the trade balance. (2 marks) Using the elementary Keynesian model, explain the effects of such a policy on equilibrium income, consumption, national saving, and the trade balance. (4 marks) (c) Based on your results, which type of expenditure policy (reducing or switching) would you recommend to the government? Why? (3 marks) 06 #1 State whether each of the following statements is true, false or uncertain. Briefly explain your answer. (5 marks each) (c) Goods are in excess supply whenever national saving exceeds domestic investment.

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