Question

Consider the possibility that government spending increases produc- tivity so that with lump sum taxes after an increase in government spending the original equilibrium level of consumption and leisure is still just affordable. How will an increase in government spending af- fect consumption, hours worked, output and welfare? What if the new PPF is beyond the original one at this point?

Answer 1

Productivity is the relationship between output and input.

Productivity = Output / Input

In this case productivity increases, means output becomes greater than input for each unit of input and it becomes more consecutively. Such increasing productivity is the cause of increasing money supply in the market through government spending.

Such increasing spending increases consumption, because people would be having excess money in their hands to go for purchasing. It shifts the AD curve, which sets relationship between output and price level, to the right.

Such increasing spending increases the number of hours worked, since working is more beneficial than leisure; the opportunity cost of leisure would be high.

  

Such increasing spending increases output (because of increasing productivity), and increases welfare (because of increasing both the consumer surplus and producer surplus).

The PPF would shift towards right, which indicates increasing the aggregate supply (AS). Since both AD and AS are increasing, there would be the minimum pressure on the price level; inflation could be restricted.

The graphical representation of various combinations of production between two goods or services with available resources or factors is PPF.

PPF curve is as below: