What will happen in the economy if the government increases spending and increases taxes by equal amounts to pay for that additional government spending?
What will be an ideal response?
An increase in spending will shift the AD curve to the right, while an increase in taxes will shift the AD curve to the left. The spending increase will have a greater impact on the economy because the full stimulus is felt in the AD shift. The tax hike will reduce both consumption and saving, so the impact on AD will not be as great. In the end AD will increase by the amount of the spending increase. As an example, assuming that the MPC is .75, then the purchases multiplier is 4, and the tax multiplier is -3. If you were to change each of the variables of purchases and taxes by the same amount such as 'x = $100,' the following possible outcome would occur. If you increase government purchases and taxes by only 'x= $100,' then by including the multiplier (4x - 3x = x = $100), the conflicting forces increase final AD by the initial change in AD.
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