Answer to Question #220917 in Macroeconomics for Gaurav Kapoor

Question

Illustrate the impact of an increase in government expenditure in the classical model

a).in case this increase is matched by a equal increase in lumpsum taxes

b). in case it is financed by an increase in money supply

Answer 1

A cut in income tax means that people keep a high % of their gross income. Therefore the multiplier effect will be higher. A cut in income tax is a withdrawal – leading to less spending and therefore it reduces the size of the multiplier.