Question

The government decides to increase expenditure by 1 and increase taxes by .5. In your own words tell me what is happening in with the graphical impact that these policies will have within the AD-AS model. Make sure they represent single adjustment .

Answer 1

Answer

Let us check the effect of the respective multipliers

The govt. expenditure multiplier = 1/(1-MPC)

The increase in expenditure is 1

net increase in economy = 1*{1/(1-MPC)}

Similarly

The tax multiplier = MPC/(1-MPC)

The increase in expenditure is -0.5

net increase in economy = 0.5*{MPC/(1-MPC)}

0<MPC<1

Judging by the multipliers only, the government multiplier is greater than the tax multiplier [1/(1-MPC)] > [MPC/(1-MPC)]

Juding by the maginitude, here also governement expnditure is greater than tax increase 1 > 0.5

Thus net effect is positive,

AD2 AD1 SRAS Price level M Real GDP

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