Chapter 21, Problem 1CYU

To determine

The reason why a $500 million increase in government spending on goods and services will generate a larger rise in real GDP than a $500 million increase in government transfers.

Explanation of Solution

A multiplier in motion will initiate when a $500 million increase in government spending on goods and services directly increases aggregate spending by $500 million because it causes an increase in real GDP (by $500 million). And, if government spending will decrease by $500 million, then the starting decrease in aggregate spending will be $500 million but an increase in tax with the same amount will decrease the aggregate spending which would be less than this amount of $500 million because tax payments can be made with money and can otherwise be saved without the preference of spending.

Whereas, an increase in government transfers would increase the aggregate spending up to the level which causes an increase in consumer spending. It means a $500 million increase in government transfers would increase the real GDP up to the times and amount were as much as a $500 million increase in government spending.

Economics Concept Introduction

Introduction: The government purchases of goods and services are the expenditures that are made by any federal, local, or state government.