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If government purchases and taxes both increase by $100 billion, calculate the net effect of these...

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

Solutions

Expert Solution

The net effect of increase in government purchases and taxes both by $100 billion, the equilibrium real GDP will rise.

Explanation

we can understand the net effect of increase in government purchases and taxes by comparing the size of change in income due to tax multiplier and government expenditure multiplier.

In order to under the net effect of these changes on equilibrium real GDP, consider following example:

For e.g

MPC (Marginal propensity to consume) = 0.75 , MTR (marginal tax rate) = 0.25 and

Change in government purchases = Change in taxes = $100 billion

Government expenditure multiplier

Tax multiplier

Therefore, the net effect of these changes on equilibrium real GDP is $58 billion

.

Rahul Sunny answered 1 year ago
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