Question #2308

If you observed the following conditions, which would be consistent with a stable GDP level?

(a) The government deficit is $10 (spending greater than tax revenue), household saving is $20, Import expenditure is $20, total investment expenditure is $20 and export sales equal $10. The unemployment rate is 10 per cent.
(b) The government deficit is $15 (spending greater than tax revenue), household saving is $20, Import expenditure is $20, total investment expenditure is $15 and export sales equal $15. The unemployment rate is 5 per cent.
(c) The government deficit is $10 (spending greater than tax revenue), household saving is $15, Import expenditure is $20, total investment expenditure is $10 and export sales equal $10. The unemployment rate is 12 per cent.
(d) The government deficit is $10 (spending greater than tax revenue), household saving is $20, Import expenditure is $20, total investment expenditure is $20 and export sales equal $15. The unemployment rate is 10 per cent.

Answer #11549

Answer: (a) The government deficit is $10 (spending greater than tax revenue), household saving is $20, Import expenditure is $20, total investment expenditure is $20 and export sales equal $10. The unemployment rate is 10 per cent.

Explanation

The answer is Option (a)

This is a question about income equilibrium, which means a state where there are not forces present that will cause GDP to change from its current level.

MOOC students learned that the national economy comes to rest (GDP is stable at that level) when the sum of the injections equals the sum of the leakages.

The injections were government spending, business investment and export spending.

The leakages were household saving, tax revenue and import expenditure.

The students also learned that GDP changes promote changes in the leakages because saving is a positive function of disposable income, tax structures usually are geared to generate more revenue as economic activity rises and import spending rises with GDP growth.

So if an equilibrium is disturbed by some new injection (say, a government stimulus package or an export boom) then a process ensues that traces the path back to a new (higher in this case) GDP level and equilibrium.

The question was thus testing this knowledge and putting some numbers to the concepts.

There was a slight twist to the arithmetic required which made the conceptual challenge a little more interesting.

It would have been too easy just laying out the values of the injections and leakages and then it would just be a simple matter of addition.

So I complicated it a little by providing one net injection - the government fiscal position, which is the difference between an injection (G) and a leakage (T).

So the simple rule for a steady-state is:

G + I + X = T + S + M

Now we can arrange that to be another way of writing the steady-state condition:

(G - T) + I + X = S + M

Which puts it into the way the question is framed.

Filling in the values gives:

Option (a): $10 + $20 + $10 equals $20 + $20 (so this is a steady-state situation)

Option (b): $15 + $15 + $15 does not equal $20 + $20 (so this is not a steady-state situation and GDP would still be adjusting)

Option (c): $10 + $10 + $10 does not equal $20 + $20 (so this is not a steady-state situation and GDP would still be adjusting)

Option (d): $10 + $20 + $15 does not equal $20 + $20 (so this is not a steady-state situation and GDP would still be adjusting)

The information about the unemployment rate was irrelevant and included to distract or rather to further test the confidence the student had in their understanding.

So the answer is Option (a).

That is enough for today!