Question

According to the closed economy one-period model, why might it not be a good idea to raise government spending to limit the drop in output that results from a decline in total factor productivity?

Answer 1

The equation for a closed economy would be,

Y = C + I + G,

Where Y = Total output, C = Consumption, I = Investment and G = Government Spending.

If there is a decline in the output due to total factor productivity then it might not be a good idea to increase the government spending. Increasing the government spending will lead to an increase in the tax. In times when there is low factor productivity then tax burden will be a problem to the people. This is why raising the government spending to limit the drop in output results from a decline in total factor productivity will not be a good idea at all.