Question

Subscribe The topic: Assume an open, mixed economy. That is, foreign trade is part of the economy, and the economy includes both a public (government) and a private (consumers and businesses) sector. Given this, aggregate demand is expressed as (C + I + G + X). Assume the MPC is .7. Assume a stimulus package of $100 billion has been approved by Congress and the money has been spent. In order to pay for those expenditures, Congress also approved a $100 billion increase in individual income taxes. (This means Congress would not allow deficit spending in order to stimulate the economy.) Will these actions by Congress expand or contract the economy or are they just useless actions? Note: Go back to the Policy Example using North Carolina as an example in Chapter 6 in your text. This is sort of the opposite scenario for the state of North Carolina. Can you see that? Start a New Thread

Answer 1

An equal increase in government expenditure and taxes will raise the equilibrium income by the increase in government expenditure. The reason for this is that the increase in government expenditure raises the income level in the economy by the amount of government expenditure directly and then indirectly through the multiplier chain.

On the other hand, the tax increase only enters the income when the reduction in disposable income reduces consumer expenditure. The difference between the two gives the net effect which is equal to the initial increase in government expenditure.

So, in the present case, the increase in the government expenditure through a stimulus package of $100 billion being matched by an increase in individual income taxes by $100 billion will result in an increase in the income level by $100 billion.