Question

Q. Consider the possibility that government spending increases productivity so that with lump sum taxes after an increase in government spending the original equilibrium level of consumption and leisure is still just affordable. How will an increase in government spending affect consumption, hours worked, output and welfare? What if the new PPF is beyond the original one at this point?

***Please do not copy from the extising answers from chegg for this question, those are not completelly correct. Thanks.***

Answer 1

When government spending increases, households experience negative wealth effect that induces less consumption. Due to this they are made to work more and the hours worked also increases. Government spending are financed through taxes on labor income etc which can affect the workers a lot. They are made to work more hours to pay for the taxes. Leisure and consumption are postponed and households work more. The output also decreases following increase in government spending. The household welfare falls when government spending increases.
The PPF will shift down along with consumption and leisure.The production will remain constant.