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Example of Balanced Budget Multiplier

The document discusses how an increase in government spending of $1000 that is matched by an increase in taxes of $1000 would impact GDP. It states that with an MPC of 0.8, GDP would increase by $1000 due to the balanced budget multiplier being equal to 1.

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Ajeet Singh
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505 views1 page

Example of Balanced Budget Multiplier

The document discusses how an increase in government spending of $1000 that is matched by an increase in taxes of $1000 would impact GDP. It states that with an MPC of 0.8, GDP would increase by $1000 due to the balanced budget multiplier being equal to 1.

Uploaded by

Ajeet Singh
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Balanced Budget Multiplier

Let's say the government increases spending by $1,000 and also increases taxes by $1,000, and the MPC equals .8. By how much will GDP change? Solution: The multiplier equals 5 and so the tax multiplier equals -4. Therefore, GDP will increase by $5,000 from the $1,000 additional government spending (5 times $1,000). And GDP will decrease by $4,000 from the additional $1,000 in taxes (-4 times $1,000). Thus, on balance, equilibrium income (GDP) will increase by $1,000 ($5,000 minus $4,000). Therefore, when the government spends $1,000 and imposes taxes of $1,000, it balances its budget, while increasing equilibrium GDP by $1,000. Thus, when the government changes spending and taxes by the same amount, then equilibrium income (GDP) changes by 1 times this amount. We say that The balanced budget multiplier = 1. The balanced budget multiplierimplies that if the government increases spending and taxation by the same amount, then equilibrium national income (GDP) rises by this amount.

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