Business: Explain the effect of a discretionary cut in taxes of $40 billion on the economy when the economy s marginal propensity to consume is .75. how does this discretionary fiscal policy differ from a discretionary increase in government spending of $40 billion?

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Explain the effect of a discretionary cut in taxes

mconcepcionmilp7rfkn

12.03.2022

We use the multiplier formula here,

$m=-\frac{MPC}{1-MPC} m=- \frac{0.75}{1-0.75} m=-3$

Therefore, we have

$m=\frac{Change in GDP}{Change in Taxes} -3=\frac{Change in GDP}{-$40} Change in GDP= $120 billion$

While, if the government used a fiscal policy by increasing government spending by $40 billion. The result would have been

$m=\frac{1}{1-MPC} m= \frac{1}{1-0.75} m= 4$

Therefore, we have

$m=\frac{Change in GDP}{Change in Government Spending} 4=\frac{Change in GDP}{$40} Change in GDP= $160 billion$

Therefore, GDP will increase by $160 billion due to an increase in Government spending by $40.

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