Question

Consider the economy of Canada. Its households spend 88% of increases in their income and saves 12%. There are no taxes and no foreign trade. Currently, Canada has a recessionary gap, the governments aim is to get actual output to increase by 140 billion dollars. How much of a tax cut do they need to have to achieve the overall increase in output of 140 billion dollars?

Answer 1

To achieve an overall increase in output of $140 billion, the government needs to implement a tax cut that corresponds to the 12% of the increase in income that is saved.

Step-by-step explanation:

To achieve an overall increase in output of $140 billion, the government needs to implement a tax cut. The households spend 88% of their income, so the remaining 12% represents savings. This means that out of the increase in income, 88% is spent and 12% is saved. Therefore, to achieve the desired increase in output, the government needs to implement a tax cut that corresponds to the 12% of the increase in income that is saved.

Let's calculate the tax cut needed:

1. Calculate the total increase in income: $140 billion / 0.88 = $159.09 billion
2. Calculate the portion of the increase in income that is saved: $159.09 billion × 0.12 = $19.09 billion

Therefore, the government needs to implement a tax cut of $19.09 billion to achieve the overall increase in output of $140 billion.