Assignment task: Assume a simple closed economy, with an MP0 equal to 0.75. The government has recently had to implement an amendment to its' balanced budget. As a result, the economy contracts and goes into a recession. Therefore, the government increases spending by US$100 million in order to stimulate the economy.
a) Calculate the change in output (AY) from the increase in government spending (AG).
b) The balanced budget amendment requires the government to also raise taxes by US$100 million. Calculate the change in output (AY) from the tax hike.
c) What is the net effect on output from these two policies? Was there any expansionary effect? Explain your working and answer in words.
d) Why is a balanced budget amendment problematic or undesirable?