Question

A $45 billion reduction in taxes increases Real GDP by $130.5 billion. Assuming a constant price level, what does the tax multiplier equal?

Answer 1

Tax multiplier= 2,9

Step-by-step explanation:

Tax multiplier represents the multiple by which gross domestic product (GDP) increases (decreases) in response to a decrease (increase) in taxes.

In the simple version of tax multiplier, it is assumed that any increase or decrease in tax affects consumption only (and has no effect on investment, government expenditures, etc.)

The formula is:

TMs=MPC/MPS=MPC/(1-MPC)

TMs= is the simple tax multiplier;

MPS= marginal propensity to save (MPS); and

MPC= marginal propensity to consume.

In this exercise, we do not possess the required information to use the general formula.

We need to use an alternative formula:

Decrease in taxes= change in GDP/tax multiplier

tax multiplier= change in GDP/Decrease in taxes

tax multiplier= 130,5billion/45billion=2,9