Suppose Congress decides to reduce transfer payments (such as welfare) but to increase government purchases of goods and services by an equal amount. that is, it undertakes a change in fiscal policy such that G = TR.

a. Would you expect equilibrium income to rise or fall as a result of this change? Why? Check your answer with the following example: Suppose that, initially, c = .8, t = .25, and Y0 = 600. Now let G = 10 and TR = 10.

b. Find the change in equilibrium income, Y0. c. What is the change in the budget surplus, BS ? Why has BS changed?