Impact of Government Policy Changes on GDP

What is the impact on GDP if the government increases unemployment benefits by $1 million and funds it entirely by raising taxes?

GDP increases by $1 million.

The government increases unemployment benefits by $1 million and funds it entirely by raising taxes. As a result, GDP increases by $1 million.

Explanation:

The change in total expenditures due to the government policy change ripples through the economy. When households receive increased benefits and spend that money on goods and services, businesses see an increase in sales. Businesses then pay their employees and suppliers, who in turn spend their income on other goods and services. This cycle continues, creating a multiplier effect where the initial increase in spending has a greater impact on GDP than the initial dollar amount spent. This phenomenon is known as the expenditure multiplier effect, where each unit increase in spending leads to a magnified increase in GDP. In this case, the absolute value of the government purchases multiplier is 3 and that of the tax multiplier is 2, resulting in an overall increase of $1 million in GDP. Overall, government policy changes can have significant impacts on GDP through the multiplier effect, highlighting the interconnected nature of the economy and the importance of understanding how changes in fiscal policy can influence economic output.