The effect of a decline in taxes on the level of income will differ somewhat from an increase in government expenditures of the same amount because:

a. tax declines tend to be more expansionary
b. households may not spend all of an increase in disposable income
c. the MPC which applies to the incomes of households always exceeds the MPC which applies to business incomes
d. the multiplier is high when the MPS is low

I assume that the MPC means Margnal propensity to Consume. I am not sure what you mean by "level of income". Answer #c. makes sense to me, if it is an income tax reduction to individuals. Answer #a also makes sense, but is not an explanation.

Money given directly to individuals as a tax reduction is more likely to be spent than government expenditure to industry.

I think the answer is b.

Total income for an economy is measured by GNP (or GDP); and GNP=C+I+G.
When government raises spending by x, GNP immediately goes up by x. However, a multipler kicks in, where the multiplier is 1/MPS. So, total spending increased spending becomes m*x, where m is the multiplier.

Now then, when taxes decrease by x dollars, disposable income goes up by x. However, households do not spend the full amount, the spend some and save some according to thier MPS. Total income goes up by x*MPC. Then the multiplier kicks in. In the end, Macroeconomics teaches that the taxation multiplier is (1/MPS)-1.

So, a is not true, tax declines tend to be less expansionary (than government spending)

c is not true, the possible differences in MPC between households and business is irrelevant.

while the statement in d is true, it does not explain the question. The multiplier of gvt is 1/MPS, for tax it is (1/MPS) -1

Now then, AMY, when you expand past 1st term macro, the world becomes more complicated. My simplistic explanation will not suffice. But do not worry about this now.

Explain Bot Explain Bot answered
9 months ago

You are correct, the answer to the question is b.

When there is a decline in taxes, the level of income will be affected differently compared to an increase in government expenditures of the same amount because households may not spend all of the increase in disposable income. This is due to the concept of the marginal propensity to consume (MPC).

The MPC represents the proportion of additional income that is spent on consumption. So, if the MPC is 0.8, it means that for every additional dollar of income, 80 cents will be spent on consumption.

In the case of a tax decline, disposable income increases, but households may not spend all of this increase. Instead, they may choose to save a portion of it. The amount they save depends on their marginal propensity to save (MPS), which is the proportion of additional income that is saved.

Therefore, the effect of a tax decline on the level of income will be smaller than the initial increase in disposable income. The total increase in income will be equal to the increase in disposable income multiplied by the MPC.

On the other hand, when there is an increase in government expenditures, the effect on the level of income is typically more immediate and tends to be more expansionary.

So, in summary, the answer to the question is b because households may not spend all of an increase in disposable income due to their marginal propensity to consume, which is a key concept in macroeconomics.