Your island economy has been thriving for many years now

Your island economy has been thriving for many years now, and has grown large, with many people, services, goods, and trade available. In your island economy, you currently have no government. You know the following information:

β€’ People seem to spend about 80% of their income.

β€’ People import (from a neighbouring island!) about 15% of their goods and services.

β€’ Business Expenditure is currently at $2,000.

β€’ Exports/year are worth $1,000

1. Determine the current level of equilibrium GDP.

2. You begin to develop a government on this island. You start with a net tax rate of 10%, and government expenditure of $600. a. Determine the new level of equilibrium GDP.

b. Determine the budget balance.

3. There is a virus in a neighbouring economy, and as a result, your exports and imports both drop to zero, respectively. Graph the impact of this on both your equilibrium GDP and budget balance. What is our GDP now, and what is our budget balance?

4. It has been estimated that your potential GDP (π‘Œπ‘ƒ) is approximately $12,000. Describe the effects of your current equilibrium GDP and your potential GDP – what will happen in your economy and why? What is our structural budget balance for this π‘Œπ‘ƒ?

5. To reach your potential GDP, describe any changes you – as the government – would make to either your tax rate or your government expenditure. Graph the changes you describe and determine the effects to GDP, Government expenditure, taxation, and budget balance.

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