Answer to Question #205348 in Macroeconomics for rahul

Question

What is the effect of change in personal taxes and the government expenditure on the circular flows of income and expenditure? Does a balanced budget policy result in expansion and reduction in the circular flows?

Answer 1

Taxes imposed by the government reduces the flow of income because an increase in taxes leads to withdrawals in the circular flow of income. Government expenditure increases the flow of income in the circular flow of income because it acts as an injection into the circular flow model. Government spending is not generated by households and is new spending in the circular flow model.

A balanced budget occurs when revenues are equal or greater than expenses, the balanced budget has an expansionary effect on circular flows since government spending is matched by an increase in taxes resulting in an increase in net income by the same amount. The balanced budget also reduces interest rates and trade deficits.