Question

When the U.S. Government proposes a fiscal stimulus package during a recession there is usually a debate in Congress as to whether the Government should: 1) increase spending directly such as building bridges and schools; or 2) reduce personal income taxes. Using the concepts of U.S. GDP accounting based on the expenditure approach: (p. 749 ch 30)

1. Explain why each of the two options would have a different initial impact on U.S. GDP
2. How could the positive expenditure impact on U.S. GDP from the actual spending stimulated by the fiscal package diminished?

Answer 1

FIRST QUESTION-

1. when government would execute the direct spending like construction of public goods such as roads,buildings,dams etc the unemployment would decline but it doesn't ensure that people would proportionally increase their consumption.if they have been unemployed then they would be in panic and would spend a limited amount on consumption and would retain a large portion of income with themselves as saving due to this the MPC would be low and MPS would be larger.therefore there is no assurance of economic recovery in short run thus the GDP may be declined.
2. when government decreases the tax rate then the net disposable income of people of a country increases as a result there would be more money with the people then earlier.they would be able to spend more.therefore this might increase the consumption expenditure of the consumers.there is a possibility that the GDP would sustain and increase due to increase in the level of production.

SECOND QUESTION-

recession is a critical and very vulnerable stage of the economy which can wipe out the entire growth of a decade in a short period of time.therefore very important,quick,and effective steps have to be taken while dealing with the recession. because if the recession is not faced effectively then the next step would be depression which could stay for a longer period.

therefore the government have to take steps in consideration with the recession the budget may be in deficit and the balance may surpass the planned expenditure in the government budget but ultimately it would

• increase the level of employment
• increase the purchasing capacity of the people
• increase the level of consumption
• prevent the economy from the vicious circle

all these steps would be helpful in the increment in the GDP.the GDP would increase because the production would be able to sustain and continue.