This problem set is due Thursday, October 30, at the beginning of the class period. Problem sets done on notebook paper or unstapled will not be accepted. Late problem sets are unacceptable also.

1. In 1997 Brazil faces a large international trade deficit (or negative net exports).

a) Draw a diagram representing the Brazilian economy during 1997 (Hint: In this diagram, equilibrium output must occur at a level in which net exports are negative; and this should be shown in your diagram).
b) Assume that the government wants to reduce the trade deficit without changing the level of national output. Describe the changes in fiscal policy and in the exchange rate that would be necessary to achieve these objectives. Use a diagram to show the effects of your proposed policy changes.

2. You are given the following information about Sivad's economy:

• Each year consumers spend $350 billion regardless of the level of their disposable income. In addition to those $350 billion, they always spend 90% of their yearly disposable income.
• Investment is fixed at $600 billion.
• Government expenditures are $500 billion.
• Net taxes equal 200.
• Exports are $250 billion.
• Imports are always equal to 15% of the level of disposable income.

a) How much would Sivad's equilibrium level of output be?

b) How much would net exports be when this economy is at equilibrium output?

c) Sivad's main export product is cobin. Due to new medical discoveries that prove cobin consumption reduces performance in economics exams, Sivad's exports fall by $100 billion to a new level of $150 billion. How much would Sivad's new equilibrium level of output be?

d) How much would net exports be when this economy is at its new equilibrium output?

e) Dr. Gates, the President of Sivad, decides that he wants equilibrium output to go back to its original level. How much would he have to decrease taxes to achieve his objective?

f) How much would net exports be when the policies of Sivad's President bring equilibrium output back to its original level?

3. You are given the following information about the U.S. economy: When unemployment is at its natural rate, which is 6 percent, government spending is 20 percent of GDP, while taxes and other government revenues are equal to 15 percent of GDP. For each 1 percentage point increase in the unemployment rate, government spending increases by 1 percentage point of GDP and taxes fall by 1 percentage point of GDP. There is no inflation.

a) In 1998, the unemployment rate is 6%. Calculate the actual, structural, and cyclical deficits (as percentages of GDP) of the U.S. government.

b) In 1999, the unemployment rate is 8%. Calculate the actual, structural, and cyclical deficits (as percentages of GDP) of the U.S. government.

c) In 2000, the unemployment rate is 10%. Calculate the actual, structural, and cyclical deficits (as percentages of GDP) of the U.S. government.

d) In 2001, the U.S. Congress and the Administration decide to cut taxes and increase government expenditures to stimulate the economy. Now you are told that when unemployment is 6 percent, government spending is 25 percent of GDP, while taxes and other government revenues are equal to 14 percent of GDP. Furthermore, as happened before, for each 1 percentage point increase in the unemployment rate, government spending increases by 1 percentage point of GDP and taxes fall by 1 percentage point of GDP. Assuming that these policies make the unemployment rate fall to 7%, calculate the actual, structural, and cyclical deficits (as percentages of GDP) of the U.S. government.

e) In 2002, the unemployment rate is 6%. Calculate the actual, structural, and cyclical deficits (as percentages of GDP) of the U.S. government (Assume that the changes that took place in 2001 are permanent).

4. You are given the following information about Depeche's economy:

• Each year consumers spend $300 billion regardless of the level of their disposable income. In addition to that $300 billion, they always spend 80% of their yearly disposable income.
• Investment is fixed at $700 billion.
• Government expenditures are $614 billion.
• Taxes equal 40% of income.
• Exports are $300 billion.
• Imports are always equal to 10% of the level of disposable income.

a) How much would Depeche's equilibrium level of output be?

b) How much would net exports be when this economy is at equilibrium output?

c) How much would the net government surplus (or deficit) be when this economy is at equilibrium output?

d) Due to lack of confidence in the economy, Depeche's investors decide to cut their investment level by $348 billion to a new level of only $352 billion. How much would Depeche's new equilibrium level of output be?

e) How much would the net government surplus (or deficit) be when this economy is at its new equilibrium output? Was this change in the surplus (or deficit) due to structural or cyclical reasons? Explain.

f) Following supply-side ideas, and in order to stimulate the economy Depeche's President, Dr. David Gahan, cuts taxes from 40% of income to a new level of only 25% of income. How much would Depeche's new equilibrium level of output be?

g) Was Arthur Laffer's prediction that a cut in the tax rate would increase the government tax revenue correct in this case? Why or why not?

5. Use the information available on the Internet at:
http://www.access.gpo.gov/su_docs/budget/index.html
to obtain the data necessary to answer the following questions.

a) How much was the yearly total budget deficit of the Federal Government from 1980 until 1996? (Note: You should look in Table 1.1 to get these numbers)

b) Was the change in the actual deficit from 1980 to 1983 mainly due to cyclical or structural reasons? Explain.

c) Was the change in the actual deficit from 1984 to 1986 mainly due to cyclical or structural reasons? Explain.

d) Was the change in the actual deficit from 1990 to 1992 mainly due to cyclical or structural reasons? Explain.

e) Was the change in the actual deficit from 1992 to 1996 mainly due to cyclical or structural reasons? Explain.

f) According to the estimates presented in Table 1.1, the Federal Government should have a budget surplus in 2002. If these estimates prove to be correct, would the change from a deficit today to a surplus then mainly be due to cyclical or structural reasons? Explain.