Question

Suppose that the average wage earner saves 3% of her take-home pay and spends the other 97%. Also suppose that 97% of any amount spent is always re-spent (with 3% saved). Estimate the impact that a proposed $35 billion tax cut will have on the economy over the long run due to the additional spending generated. (Round your answer to the nearest integer.)

Answer 1

A proposed $35 billion tax cut will make $1,132 billion to be circulated through the economy over the long run due to the additional spending generated.

Step-by-step explanation:

MPS = Marginal propensity to save = Average wage earner saves = 3%, or 0.03

MPC = Marginal propensity to consume = Average wage earner spends = 97%, or 0.97

Tax multiplier = - MPC/MPS = - 0.97/0.03 = - 32.3333333333333

Tax cut = - $35 billion

Impact of $35 billion tax cut = Tax multiplier * Tax cut = (- 32.3333333333333) * (- $35 billion) = $1,132 billion

Therefore, a proposed $35 billion tax cut will make $1,132 billion to be circulated through the economy over the long run due to the additional spending generated.