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A note on the simple balanced budget multiplier. (Anthology).

In principles of macroeconomics textbooks, the simple balanced budget multiplier is always unity. This is because a change in government expenditure is reflected dollar for dollar in aggregate demand, while a change in lump-sum taxes only leads to a fraction of a dollar's increase or decrease in consumption spending and the rest is saved or dissaved by the public. This note will show that the simple balanced budget multiplier becomes 1 only when public spending from lump-sum tax revenue is irrelevant to the labor-leisure choice of the public.

Assar Linbeck ["Tax Effects Versus Budget Effects on Labor Supply," Economic Inquiry, 1982] points out that pure collective goods, such as national defense and law and order, have no influence on the labor-leisure choice but parks and wildlife refuges and recreation related facilities are complementary to leisure. Gordon Winston ["Taxes, Leisure and Public Goods," Economica, 1965] also points out that when leisure and public spending are complementary, the ordinal cross effect of the spending change on the demand for leisure is positive. This implies that if a decrease in total government spending to balance its budget comes only from recreation related expenditures, the outcome would be an increase in the work effort. As a result, the public now has more income to spend on consumer goods and services. This, in turn, would shift upward the aggregate demand curve and counters the downward shift in the aggregate demand curve caused by the decrease in government spending. Hence, the simple balanced budget multip lier is less than 1.

However, if public spending and leisure are independent, a change in government spending has no effect on the work effort. Thus, there is no change in induced income to counter the shift in the aggregate demand curve caused by the change in public spending. Hence, the simple balanced budget multiplier becomes 1.

It is concluded that the type of public spending and its relations to the labor-leisure choice are an important determinant of the simple balanced budget multiplier. The implicit assumption of government spending having no effect on the work-leisure choice is only partially valid and thus leads to analytic distortion in the determination of the simple balanced budget multiplier. (JEL A00, E00)

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Author:Glasure, Yong U.
Publication:Atlantic Economic Journal
Article Type:Brief Article
Geographic Code:1USA
Date:Mar 1, 2002
Words:367
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