Question
Fiscal Policy.
(a) The economic effect of an increase in government purchases is likely to depend on how the purchases are financed. Explain how an increase in G is increases output and employment if financed by a lump-sum tax (or debt), but is likely to decrease output and employment if financed with an income tax.
(b) The economic effect of an increase in government purchases is also likely to depend on the what the increased spending is used for. Suppose that the increase in spending is used to finance a school lunch program-goods and services that are viewed as perfect substitutes for privately-supplied school lunches by the private sector. Explain why such a program is unlikely to have much of an impact on output and employment even if it is financed with a lump-sum tax.
