Question

Explain the effect of a discretionary cut in taxes of $60 billion on the economy when the economy’s marginal propensity to consume is 0.8. How does this discretionary fiscal policy differ from a discretionary increase in government spending of $60 billion?

Answer 1

Answer :- An increase in the spending increases aggregate demand or aggregate expenditure or real GDP in the economy more than the underlying change in the government spending as the spending by government is a pay of somebody and that spends it according to the peripheral penchant to devour so the impact is multiple of multiplier.

Multiplier =1/(1-MPC)

=1/(1-0.8)

=5

Thus, the multiplier is 5.

• The change in AD or AE or real GDP in the economy because of the change in spending =intial change in spending * multiplier.

=60*5

=$300 billion

Thus, the real GDP eventually increases by $300 billion.

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