When government spending increases and taxes are increased by an equal amount, interest rates: A. Increase B. decrease C....
Homework Answers
Answer
Government expenditure multiplier is 1/(1 - MPC) and Tax multiplier is -MPC/(1 - MPC) where MPC = Marginal propensity o consume and 0 < MPC < 1.
Thus, Government expenditure multiplier > Tax multiplier. Hence Increase in Both by equal amount will result in increase in Equilibrium Output in the Goods market and thus IS curve will shift to the right.
This Rightward shift of IS curve will result in increase in both equilibrium output and interest rate.
Hence, the correct answer is (A) increase.
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