Answer to Question #218588 in Macroeconomics for urvi

Question

In Keynesian model, discuss the effects of changes in fiscal variables - increase in government purchases, reduction in tax rates and increase in transfer payments on equilibrium level of income

Answer 1

According to the keynesian model,

i. Increase in government purchases results in an increase in business activity and there will be more government expenditure.This model improves aggregate output and leads to generation of more income.

ii

Reduce in tax rates

When tax rates decrease, the rate of consumption goes up leading to an increase in output/income. The increase in income increases the demand for money. Given that money supply is fixed, interest rate must reduce to pull down demand for money and to maintain equilibrium.

iii

Increase in transfer payments

Transfer payments are negative taxes and their increase leads to multiple aggregate demand. This is because spendable funds are transferred to consumers who may spend some of all of them. Increase in transfer payments leads to an increase in income enabling the recipient to spend it on more goods.