Question

Suppose that the economy starts with a balanced budget: G = T. If the increase in G is equal tothe increase in T, then the budget remains in balance. Let us now utilize the balanced budget multiplier.Suppose that Gand Tincrease by one unit each. Using the government spending multiplier and the tax multiplier (which forms the balanced budget multiplier), what is the change in equilibrium GDP?

Answer 1

Answer:

equilibrium GDP increase by 1 as well.

Explanation:

As government spending multiplier is:

1/(1 - marginal propensity to consume)

while taxes is:

marginal propensity to consume / ( 1 - marginal propensity to consume)

the multiplier when considering an increase in government spending financed with taxes will be:

government multiplier - tax multiplier

( 1 - marginal propensity to consume)/ ( 1 - marginal propensity to consume) = 1

as the multiplier is 1 and increase of 1 will mean an increase of 1 unit in the equilibrium GDP as weill