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Explain why the tax multiplier is smaller in absolute value than the government expenditure multiplier. |
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Answer» The tax multiplier is smaller in absolute value compared to the govt, expenditure multiplier. This is because, the govt, expenditure directly affect the total expenditure and taxes enter the multiplier, process and put impact on the disposable income. Disposable income influences the consumption expenditure of households. Therefore, the tax multiplier is always less in absolute value than the govt, expenditure multiplier. For example, assume that MPC = 0.75, then Govt, expenditure multiplier = \(\frac{1}{1-c}\), C stands for MPC = \(\frac{1}{1-0.75}\) = \(\frac{1}{0.25}\) = 4 Tax multiplier = \(\frac{-c}{1-c} = \frac{-0.75}{1-0.75} = \frac{-0.75}{0.25}\) = -3 (absolute value is 3) Thus, it is clear from the example, that tax multiplier is smaller than govt. expenditure multiplier. |
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