Suppose the government decides to reduce transfer payments but increase government
purchase of goods and services by an equal amount i.e. ∆G=-∆TR (5 points)
a. Would equilibrium income rise or fall as a result of this change? Show using the
following data c=0.8, t=0.25, Y 0 =600, ∆G=10=-∆TR. (2)
b. Find the change in equilibrium change in income ∆Y 0 (2)
c. What is the change in budget surplus? Why has it changed? (1)
a
We also know,
Thus, change in equilibrium income due to change in taxes = 25
The expenditure multiplier is given as,
We also know,
Thus, change in equilibrium income due to change in Expenditure = 50
Thus, equilibrium income rises as the expenditure multiplier is stronger than the tax multiplier.
b.
So, Change in Total Income = 50 - 25 = 25
c.
Thus, Budget surplus changes because the expenditure multiplier is stronger than the tax multiplier
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