Answer:The government increases both taxes and spending by $500 billion. How does this effect the AD/AS model?

Question

Answer to the post by Miss Mathers

Y = C + I + G

= Co + c(Y-T) + Io - br + Go

Expanding,

Y - cY = Co + Io + Go - cT - br

Y = 1/(1-c) x [Co + Io + Go - cT - br]

If Go = T = $500billion

Go - cT = 500billion(1 - c)

Since c < 1,

Go - cT > 0

Hence, overall, output (Y) will increase, consumption (C) increase.

C increase will result in rightward shift of the AD curve. Sorry, accidentally deleted the answer.

Answer 1

Let MPC=0.5

ΔY/ΔG=1/(1-MPC) =1/0.5=2

ΔY/ΔT=-MPC/(1-MPC)= -0.5/0.5= -1

Taxes reduce AD by -500 Billions

Gov spending increase AD by 500*2=1&#039;000 Billions

AD will shift rightward by 1&#039;000-500=+500 billions

Answ:

In AD/AS model it will cause price level to rise and GDP to rise (depending on long/short-runs) because tax multiplier is less than gov spending multiplier.