The new government expenditure line is C 1+ G which determines OY income at point E. Now government expenditure of GE amount is injected into the economy which is equal to the tax yield AG. As a result, the consumption function shifts downward to C 1. C is the consumption function before the imposition of the tax with income at OY 0 level. This balanced budget multiplier or unit multiplier is explained in Fig. Which indicates that the change in income (∆Y) will equal the multiplier (1/1-c) times the change in autonomous government expenditure. In the balanced budget multiplier, the tax multiplier is smaller than the government expenditure multiplier. The balanced budget multiplier is based on the combined operation of the tax multiplier and the government expenditure multiplier. Thus the government expenditure rises more than the fall in consumption expenditure due to the tax and there is net increase in national income. On the other hand, government expenditure increases by the full amount of the tax. Therefore, when only a portion of an economy’s disposable income is used for consumption purposes, the economy’s consumption expenditure will not fall by the full amount of the tax. The basis for the expansionary effect of this kind of balanced budget is that a tax merely tends to reduce the level of disposable income. In this the increase in taxes (∆T) and in government expenditure (∆G) are of an equal amount (∆T=∆G). The balanced budget multiplier is used to show an expansionist fiscal policy. This brings reduction in national income from OY to OY 1. With the fall in the consumption function, the total expenditure curve (C+I+G) also revolves downward to C+I+G-T and intersects the 45° line at E 1. When AT tax is levied, the C curve revolves downward to C 1. 3, where C is the consumption function before the tax is levied and OY is the income level. Consequently, the national income declines due to the tax multiplier. Second, if the government levies a proportional income tax, this also brings a fall in the consumption function due to a decline in disposable income of the people. This intersects the 45° line at E 1 and the national income is reduced from OY to OY 1. With the decline in the consumption function, the total expenditure curve (C+I+G) also shifts downward to C+ I + G-T curve. As a result, the disposable income is reduced and the consumption function shifts downward from C to C 1. Before the levy of a lumpsum tax, C is the consumption function and the income level is OY. Government usually levies two types of taxes, lumpsum and proportional.įirst, we explain lumpsum tax multiplier in Fig. On the other hand, reduction in taxes has the multiplier effect of raising the national income. This brings a fall in national income due to the multiplier effect. When the government increases a tax rate (T) or levies a new tax, the marginal propensity to consume (c) of the people declines because their disposal income is reduced. When the government changes the tax rates, the relation between disposable income and national income changes.
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