Author Question: Which has a larger effect on aggregate demand: an increase in government expenditure or an equal ... (Read 50 times)

acc299 · **on:** Jun 29, 2018

Which has a larger effect on aggregate demand: an increase in government expenditure or an equal sized decrease in taxes? Explain your answer.

What will be an ideal response?

Question 2

It makes sense to measure relative costs in terms of leisure time

A) because leisure time is of equal value to everyone.
B) because leisure time is the ultimate good.
C) only if leisure time is of equal value to everyone.
D) only in societies with labor-saving technologies.

joanwhite · **Reply #1 on:** Jun 29, 2018

Answer to Question 1

The multiplier for a change in government expenditure is larger than the multiplier for a tax cut so the effect on aggregate demand from the increase in government expenditure exceeds that from the decrease in taxes. The difference occurs because with an increase in government expenditure on goods and services, real GDP is immediately increased. This increase then leads to a multiplier effect as household's incomes increase and so their consumption expenditure increases. With an equal sized tax cut, however, households save part of the increase in disposable income. As a result, the first impact on real GDP is smaller, which leads to a smaller effect after the multiplier is taken into account.

Answer to Question 2

C