Government Surplus
An email from a student:
The short answer is that in this model government surpluses are considered savings. Increased savings shift the supply curve to the right. Debt plays no role in the market for loanable funds.
The long answer: I'm not sure if the Professor has shared with you the national income accounts identity:
Y = C + G + I
This equation just says that income (Y) has to equal expenditures (consumption, C, and government spending, G) plus investment. From an individual's point of view, this equation makes sense, you either save or spend your income. The model we're studying in this class takes that insight and aggregates across all individuals in the economy. The only difference is we add in the government.
You can re-write the equation:
Y - C - G = I
and because taxes (T) are paid by individuals and taken in by the government as revenue, you can add and subtract T from the left hand side and re-write as:
(Y - C - T) + (T - G) = I
This new equation just says private savings (income minus taxes and consumption) plus public savings (government revenue minus government spending) equals investment. This is our equilibrium condition in the loanable funds market with the left side of the equation supply and the right side demand.
For our problem then (T - G) got bigger making the left side of the equation (supply) bigger.
...
By the way, I share your confusion with this problem. While the above analysis 'works' (and you should make sure you understand it and can reproduce it for the exam tomorrow), I'm not clear as to the mechanism for government surpluses to increase supply. *How* do surpluses increase the supply for loanable funds? I dunno.
The flip side, government deficits, is easier to see, IMHO. With deficits, the government must borrow funds. This borrowing 'crowds out' private investment, i.e. the supply for funds goes down.
Will-
I just looked at the correct reponses to the most recent homework, and I
was curious about the last question. In the book, it says that if the
government faces a budget surplus, it will use that money to pay for some
of the national debt. Therefore i thought the graph should remain
unchanged. But the correct answer showed a shift of the supply curve in the
right direction. I was wondering why this was?
Thanks,
[name withheld]
The short answer is that in this model government surpluses are considered savings. Increased savings shift the supply curve to the right. Debt plays no role in the market for loanable funds.
The long answer: I'm not sure if the Professor has shared with you the national income accounts identity:
Y = C + G + I
This equation just says that income (Y) has to equal expenditures (consumption, C, and government spending, G) plus investment. From an individual's point of view, this equation makes sense, you either save or spend your income. The model we're studying in this class takes that insight and aggregates across all individuals in the economy. The only difference is we add in the government.
You can re-write the equation:
Y - C - G = I
and because taxes (T) are paid by individuals and taken in by the government as revenue, you can add and subtract T from the left hand side and re-write as:
(Y - C - T) + (T - G) = I
This new equation just says private savings (income minus taxes and consumption) plus public savings (government revenue minus government spending) equals investment. This is our equilibrium condition in the loanable funds market with the left side of the equation supply and the right side demand.
For our problem then (T - G) got bigger making the left side of the equation (supply) bigger.
...
By the way, I share your confusion with this problem. While the above analysis 'works' (and you should make sure you understand it and can reproduce it for the exam tomorrow), I'm not clear as to the mechanism for government surpluses to increase supply. *How* do surpluses increase the supply for loanable funds? I dunno.
The flip side, government deficits, is easier to see, IMHO. With deficits, the government must borrow funds. This borrowing 'crowds out' private investment, i.e. the supply for funds goes down.
