Question

According to the balanced budget multiplier, an increase in government spending of $10,000 that is financed by an increase of $10,000 in taxes will have what effect on the economy when mpc is 0.80?

Answer 1

Income will be increased by $10,000

Step-by-step explanation:

i

Increase in GDP because of increase in government spending =govenment spending *spending multiplier

Mathematically;

spending multiplier=1/(1-MPC)

=1/(1-0.8)

=5

The increase in GDP because of increase in government spending =5*10000

=50000

The decrease in GDP because of increase in taxes=taxes*tax multiplier

tax multiplier=-MPC/(1-MPC)

=-0.8/(1-0.8)

=-4

The decrease in GDP because of increase in taxes=4*10000=40000

The total change in GDP=spending change -tax change

=50000-40000

=10000