Question

If government purchases and taxes both increase by $100 billion, calculate the net effect of these changes on equilibrium real GDP. Show your work.

Answer 1

Answer: the net effect is 0.

GDP is the aggregate of all spending in an economy within a specific period. This is formulate as below:

GDP = (C –T) + I + G

Where, GDP = gross domestic product

C = Consumption spending

T = Tax

I = Private investment spending

G = Government spending

Note: all figures are in billion dollar.

Suppose before any change the equilibrium GDP is as below:

GDP = (C –T) + I + G

         = (300 – 0) + 200 + 150

         = 300 + 200 + 150

         = 650

Now there is an increase in G by 100 and T by 100. Then the equilibrium GDP would be as below:

GDP = (C –T) + I + G

         = (300 – 100) + 200 + (150 + 100)

         = 200 + 200 + 250

         = 650

Since GDP before change and after change both are same, there would be no change in equilibrium GDP. The net effect is 0.