Question

Assume that the slope of the consumption line is 3. If G increases by a 1000 and  if taxes increase by the same amount (1,000), by how much will the national income change? This is the case of the balanced budget multiplier.

Answer 1

According to balanced budget multiplier concept, an increase in Government spending and taxes simultaneously by the same amount will increase the national income by the amount of increase in government spending.

So, if G increases by 1000 and taxes increase by 1000, then according to balanced budget multiplier the national income by 1000 only.

Answer: National income will increase by 1000.

Proof:

Slope of consumption line = 0.3

=> MPC = 0.3

So, government spending multiplier = 1 / (1-MPC) = 1 / (1-0.3) = 1.43

Tax multiplier = -MPC / (1 - MPC) = -0.3 / 0.7 = -0.43.

BBM = Govt. Spending multiplier + Tax multiplier

BBM = 1.43 + (-0.43)

BBM = 1.43 - 0.43

BBM = 1

Since the value of BBM is 1.

It means the national income will increase by the change in the amount of G.