Answer to Question #228161 in Macroeconomics for Fateh

Question

Suppose the economy is operating at equilibrium, with Yo=1,000. If the government undertakes a fiscal change whereby the tax rate, t , increases by .05 and government spending increases by 50, will the budget surplus go up or down? Why?

Answer 1

A budget surplus exist where Income (Y) exceeds Expenditures;

When tax increases, the income (Y0) decreased as shown below:

1000 - 0.05(1000) = 950

On the other hand, increase in government expenditure, income increases as illustrated below;

950 + 50= 1000

To determine budget surplus

At equilibrium, income = Expenditures, whereas a budget surplus Income exceeds surplus, therefore from above;

Income (Y1) = 1000, whereas new Expenditure =1000

Conclusion: Budget surplus equals to zero (did not change) because the rate of government expenditure increase was the same as tax rate increase.