Question

Suppose that marginal propensity to consume is equal to 0.8 .The government has the balanced budget right decide to increase government spending by $100 billion. This increase in spending is partially financed by a $50 billion They now. increase in taxes. Answer following questions: a) As a result of this, what happen to GDP? b) As a result of this, what happen to government budget (still we have the balanced one, or it creates deficit or it creates any unbalanced budget surplus. If name it and find the amount) TE Arial T TT 3 (12pt)

Answer 1

MPC=0.8

MPS=1-MPC

=1-0.8

=0.2

Spending multiplier=1/MPS

=1/0.2

=5

Tax multiplier=-MPC/MPS

=-0.8/0.2

= -4

a.

When government increases its spending by $100 and $50 is financed by the increase in the tax.

Hence change in the GDP= Spending multiplier* change in the G + tax multiplier * change in the Tax

=5*100+ (-4)*50

=500-200

=$300

Hence GDP will increase by $300.

b.

Government budget= Tax revenue - government spending

=50-100

= (-$50)

Government budget deficit= (-$50)

There will be deficit of $50.

The unbalance budget name is government budget deficit and it is $50.