Question

According to the balanced budget multiplier, an increase in government spending of $10,000 that is financed...

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?

a)

 Income will not change.

b)

 Income will increase by $8,000.

c)

 Income will increase by $50,000.

d)

 Income will increase by $10,000.
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Answer #1

Answer
Option d
The increase in GDP because of increase in government spending =govenment spending *spending multiplier
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

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