If a government raises its expenditures by $50 billion and at the same time levies a lump-sum tax of $50 billion, the net effect on the economy will be to:
a. increase GDP by less than $50 billion
b. increase GDP by more than $50 billion
c. increase GDP by $50 billion
d. make no change in GDP
Take a shot. Remember the difference between a taxation multiplier and a government spending multiplier.
jki
To determine the net effect on the economy, we need to consider the impact of both the increase in government expenditures and the imposition of a lump-sum tax.
When the government raises its expenditures by $50 billion, this injection of funds into the economy can have a multiplying effect. It's important to note that the impact of government spending on the economy is determined by the fiscal multiplier. The fiscal multiplier represents the change in overall economic output (GDP) resulting from a change in government spending.
On the other hand, when a lump-sum tax of $50 billion is levied, it has a direct effect on disposable income. A lump-sum tax is considered to have no impact on consumption decisions since it does not vary with income.
In this scenario, with the increase in government expenditures being equal to the lump-sum tax, the effect on the economy can be analyzed by considering the difference between the fiscal multiplier and the taxation multiplier.
The fiscal multiplier typically has a positive effect on GDP, as government spending stimulates economic activity. However, the taxation multiplier has a negative effect on GDP since taxes reduce disposable income, leading to a decrease in overall consumption.
Given that the increase in government expenditures is offset by the lump-sum tax of the same amount, the net effect on the economy will be a combination of the positive fiscal multiplier and the negative taxation multiplier.
Therefore, the answer is (d) make no change in GDP. The positive impact of government expenditure is offset by the negative impact of the lump-sum tax, resulting in no net change in GDP.