Chapter 4R, Problem 24MCQ

To determine

To determine what effect does an increase in government spending has in contrast to an increase in taxes.

Explanation of Solution

Change is output due to change in taxes is given by:

  $\frac{dY}{dT}=\frac{-c}{\left(1-c\right)}$

Change in output due to change in government spending is given by:

  $\frac{dY}{dG}=\frac{1}{\left(1-c\right)}$

here, $dY$ = change in output

  $dT$ = change in taxes

  $dG$ = change in government spending

  $c$ = marginal propensity to consume (0

Hence, compared to the effect of change in taxes on change in output, the change in output due to change in government spending has a larger, positive effect.

Thus, option ‘c’ is the correct option.

An increase in government spending cannot have a negative effect on output. Hence, options (a) and (b) are incorrect.

Increasing government spending will have a larger effect than increasing the tax rate. Hence, options (d) and (e ) are incorrect.

Economics Concept Introduction

An increase in government spending has just the opposite effect of an increase in taxes. So, they do not offset each other effects.