Question

If government revenues are very elastic with respect to GDP or personal income, what would tend to happen to government revenue over the course of a business cycle? How would they track growth of income over the long term? How does that make budgeting difficult for state governments that are required to balance their budgets?

Answer 1

If government revenue is elastic to GDP it means that a little rise in government spending will reduce GDP by very much and vice versa. We have four phases in business cycle:

• Trough Period where economy is at its lowest and unemployment is at its highest. Government tring to spend more money into the economy will reduce GDP by much.
• During expansion phase, GDP is rising where government spending muct be falling by a little.
• During the peak period of economic cycle, rise in infrastructural growth by government will reduce the GDP which takes into in contraction phase.
• In contraction phase, government tends to spend more money to raise the economic growt but it tends to fall more.

It makes budgeting difficult for state government because when they tends to spend money, economy falls and vice versa. They have to sdopt such policy that economy should grow without injecting much money or raise investment / consumption level to raise real GDP.