Question

1.) If you were the economic adviser to the president and the government’s goal is to stimulate the economy by increasing GDP by $2,400 billion, which one will you recommend to achieved this GDP target? Government spending or tax cut? Why?

Answer 1

If the objective is to stimulate the economy, then the best option is increase in government spending. This is because the impact of government spending on the gross domestic product (GDP) is direct and more assured as compared to tax change. Reason for this is that in the case of government spending the GDP is initially increased directly by the amount of increase in government spending and then indirectly through the multiplier effect. On the other hand, changes in taxes will affect the GDP only when its impact on the disposable income affects the consumption expenditure. So, even after reduction in taxes if the consumers decide to save rather than spend the additional income, the impact of tax reduction on the GDP will be minimal.