Question 1 (Budget Deficit): Assume an economy initially has a balanced budget (

Question

Question 1 (Budget Deficit): Assume an economy initially has a balanced budget (tax revenues are equal to the government spending). Marginal propensity to consume (MPC) in this economy is 0.75. For each of the fiscal policies below, first determine how much the GDP changes first and then calculate the resulting change in the government budget (what is the size of resulting surplus or deficit?) (2)

a. Government spending increases by $1000 while taxes stay same.

b. Taxes increase by $1000 while government spending stays same.

Explanation / Answer

Answer a : As government spending increases than there is increase in the GDP because as government spending is a way of increasing the economic growth of the country. The result is that when the economy has been grown as well as output has been increased. The result is that there is increase in the GDP.

There is a budget deficit as spending is more than the revenue collected by the government. The budget deficit of $1000.

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Answer b : As taxesincreases than there is decrease in the GDP because as consumpation, saving and investment are decreasing which result in slow economic growth of the country. The result is that when the economy has been slow as well as output has been decreased. The result is that there is decrease in the GDP.

There is a budget surplus as revenue is more than the spending collected by the government. The budget surplus of $1000.

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