Question

4. The balanced budget multiplier For both political and macroeconomic reasons, governments are often reluctant to run budget deficits. Here, we examine whether policy changes in G and T that maintain a balanced budget are macroeconomically neutral. Put another way, we examine whether it is possible to affect output through changes in G and T so that the government budget remains balanced.

a. By how much does Y increase when G increases by one unit?

b. By how much does Y decrease when T increases by one unit?

c. Why are your answers to parts and b different? Suppose that the economy starts with a balanced budget: G = T. If the increase in G is equal to the increase in T, then the budget remains in balance. Let us now compute the balanced budget multiplier.

d. Suppose that G and T increase by one unit each. Using your answers to parts and b what is the change in equilibrium GDP? Are balanced budget changes in G and T macroeconomically neutral?

e. How does the specific value of the propensity to consume affect your answer to part a? Why?

Answer 1

a)

In the goods market equilibrium,

is the multiplier so Y increases by when G increases by one unit.

b)

is the tax multiplier, so Y decreases b when T increases by one unit.

c)

The answers differ because government spending affects demand directly, but taxes affect demand through consumption, and the propensity to consume is less than one.

d)

The change in Y equals - =1 . Adjusted budget changes in G and T are not macroeconomically nonpartisan.

e)

The propensity to consume has no impact on the grounds that the fair budget tax increment prematurely ends the multiplier procedure. Y and T both increment by on unit, so disposable income, and thus utilization, don't change.