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Government Purchases/Expenditures
Question Description

The Case:

Mega projects are crucial not only for the region but also for the individual livelihood. Population and their requirements are increasing with the passage of time. China Pakistan economic corridor (CPEC) is a mega project. It is the frame work of regional connectivity. This project will boost the economic activities not only for the people of Pakistan but also for the people of region. Besides, on one side this project will create many opportunities in the shape of employment, investment, more trade, more contact and more tax revenue for Pakistan while on the others hand, government development and non development expenditures will also be increased.

Requirement:

Keeping in view the above facts and figures, explain logically that how government expenditures/purchases would affect consumption in the economy of Pakistan.

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dear  how government expenditures/purchases would affect consumption in the economy of Pakistan with CPEC ..yeh search krna hy

We all know that people spend a part of their income on consumption, a part is used to pay taxes and save the rest i.e. Total income, Y = C+S+T. Taxes imposed by govt. take a part of the income away from the household and disposable income becomes, Y* = C + S or Y - T.

Let us define a variable ‘c’ = marginal propensity to consume, it is the fraction of total additional income that people use for consumption.

Similarly, suppose planned investment demand of firms = I, also a given item.

Planned Govt. expenditure = G

Taxes imposed by govt. = T

Thus aggregate demand for final goods in economy, AD = demand due to planned consumption + planned investment demand + demand on account of govt. expenditure.

i.e. AD = C*+ c.Y* + I + G = C*+ I + G + c (Y - T)

When the final goods market reaches equilibrium, aggregate demand = output of goods and services in economy = National income/ GDP.

i.e. Y = C*+ I + G + c (Y - T)

ΔY = ΔG + c ( ΔY - ΔT) since planned investment and minimum consumption level does not change (ΔC* = ΔI = 0)

Now coming to your question when ΔG = ΔT, we have

ΔY / ΔG = (1-c) / (1-c) = 1

This means national income increases by the same amount by which govt. spending increases, and the balanced budget multiplier is unity. For instance if G increases in a fiscal year by 500 the equilibrium income would also increase by 500 in this case.

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