Suppose the government were to increase government purchases by $50 billion with

Question

Suppose the government were to increase government purchases by $50 billion without changing the level of net taxes. This would shift the aggregate expenditure line up by $50 billion. After the multiplier process has run its course, the new level of aggregate output demanded will be $200 billion, implying that the value of the relevant multiplier is Now, suppose the government we net taxes by $50 billion without changing the level of government purchases. This would shift the line by, After the multiplier process has run its course, the output demanded will be, implying that the value of the relevant multiplier is . Compare your results from the previous questions. For a given magnitude of fiscal policy (in this case, a $50 billion increase in government purchases or a $50 billion decrease in net taxes), the magnitude of the change caused by the increase in government purchases is the magnitude of the change caused by the decrease in taxes. What explains this result? The two changes must be equal, because an increase in spending must have the same effect as a decrease in taxes. Taxes distort the incentives faced by households and firms, while government purchases do not. When the government increases spending, it creates new infrastructure, which increases the capital stock of the country. On the other hand, tax cuts go directly to consumption, which results in less economic growth. When the government increases spending, aggregate expenditure increases by the entire amount of the increase; but when the government lowers taxes, aggregate expenditure increases by less because some of the tax cut goes to saving.

Explanation / Answer

declined, by $50 billion, less than $200 billion and multiplier is less than 4

option D is correct

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