Question
There is a clear economic reason why an increase in government spending has a more favorable impact on unemployment than a tax reduction. It is
There is a clear economic reason why an increase in government spending has a more favorable impact on unemployment than a tax reduction. It is because there is a difference in the "multiplier" effect between the two. Here is how:
To reduce unemployment without increasing government spending, taxes must be cut. This increases disposable income, which is likely to add to consumption, which will lead to an increase in output and employment, and hence income, etc. However, the tax multiplier is not the same as the government spending multiplier. This is because government spending increases aggregate expenditures dollar for dollar, while a tax cut leads to increased dollars of disposable income andonly part of those dollars are spent(the MPC). The rest is increased saving. The tax multiplier is the ratio of the change in the equilibrium level of output to a change in taxes.In an economy with only autonomous taxes the tax multiplier equals MPC/(1-MPC) = MPC/MPS.
Suppose the government increases expenditure by $10,000,000 to build a new highway and this money goes totally to pay the workers who then spend the money. If the Marginal Propensity to Consume (MPC) of these workers is 0.8, what is the total amount of money added to the economy by this government spending after the multiplier takes effect?
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started