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 by After the multiplier process has run its course, the new level of aggregate output demanded will be implying that the value o' the relevant multiplier is Now, suppose the government were to decrease net taxes by $50 billon without changing the level of government purchases. This would shift the aggregate expenditure line by After the multiplier process has run its course, the new aggregate 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 billon 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 m taxes. What explains this result? 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. 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. The two changes must be equal, because an increase in spending must have the same effect as a decrease in taxes

Explanation / Answer

Answer. You did not mention the numerical data, so it is not possibble to fill the blanks without knowing the actual figures.

Paragraph 1: The GDP will increase by government purchases times the multiplier effect. Suppose the Government increases its expenditure by $50 billion and the value of multiplier is 2, then the GDP will increase by $100 billion. And this lead to increase in aggregate demand, the aggregate demand curve will shift to right.

Paragraph 2: Now, a decrease in taxes, the GDP will increase because this is also the case of fiscal expansion. If the taxes are lump sum, then the value of multiplier will remain same as in the previous question but if the per unit taxes have decreased, then the value of multiplier will rise.

Paragraph 3 : The question says that the government has decreased the tax by $50 billion, (lump sum taxes), so in this case the value of muliplier will not change and the effect of an increase in the government spending or a decrease in the lumpsum taxes will yield the same result.

But in the case of per unit taxes then the value of multiplier will increase, and in this case the decrease in taxes will have more effect then the increase in the government sending.

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