Question

Explain the balanced budget multiplier.

Answer 1

The change in national revenue (output) that happens when the government raises taxes and spending by the same amount is known as the “balanced budget multiplier”. National income rises even though the budget stays balanced, meaning the fiscal deficit stays the same. This is a Keynesian economics idea. 

Balanced Budget Multiplier (BBM) = Government Expenditure Multiplier + Tax Multiplier 

= `1/(1 - c) + (-c/(1 - c))`

= `(1 - c)/(1 - c)`

= 1

Where c = Marginal propensity to consume (MPC)

• Aggregate demand is entirely increased by government spending.
• People save some of their income, thus taxes only partially limit disposable income.
• As a result, spending has a greater positive impact than taxes, which raises income overall.