Q4. Last year, while a hypothetical ... [FREE SOLUTION]

Chapter 13: Q4. (page 283)

Last year, while a hypothetical economy was in a recession, government spending was $595 billion, and government revenue was $505 billion. Economists estimate that if the economy had been at its full employment level of GDP last year, government spending would have been $555 billion and government revenue would have been $550 billion. Which of the following statements about this government鈥檚 fiscal situation are true?
The government has a non鈥揷yclically adjusted budget deficit of $595 billion.
The government has a non鈥揷yclically adjusted budget deficit of $90 billion.
The government has a non鈥揷yclically adjusted budget surplus of $90 billion.
The government has a cyclically adjusted budget deficit of $555 billion.
The government has a cyclically adjusted budget deficit of $5 billion.
The government has a cyclically adjusted budget surplus of $5 billion.

Short Answer

Expert verified

Option (e): The government has a cyclically adjusted budget deficit of $5 billion.

Step by step solution

Meaning of cyclically adjusted budget

A cyclically adjusted budget is a method to compare the fluctuations in revenue to that level achieved under a full employment situation. The revenue of an economy changes according to its GDP.

When GDP falls, revenue also falls. Through a cyclically adjusted budget, economists measure what the federal budget should be under the full employment situation. The cyclically adjusted budget is also called the full-employment budget.

Explanation for the answer

The government revenue has declined as the government spending, or GDP declined due to the recession creating a budget deficit of $90 billion (=595-505). If the impact of the cyclical phenomenon was eliminated and the economy was at the full employment level, the budget deficit must vary from $90 billion.

Under the full employment situation, the budget deficit (spending revenue) would have been $5 billion only (=555-550). Therefore, the government鈥檚 fiscal position has a cyclically adjusted budget deficit of $5 billion.

Hence, option (e) is correct.