Question

Two​ countries, A and B​, both are currently in recession. The values of the MPS for A and B are 0.1 and 0.5 respectively. The governments of both countries are planning to boost income through an expansionary policy of a tax cut of​ $1 billion.

The policy of tax cut:

A) may have the same effect on income, because it depends on MPC and not on MPs.
B) will be less effective in country B than in country A since the value of the tax multiplier is lower in country B.
C) will be more effective in country B than in country A since the value of the tax multiplier is larger in country B.
D) will more effective in country B than in country A since the value of the tax multiplier is lower in country B and tax multipliers are negative.

Answer 1

B) will be less effective in country B than in country A since the value of the tax multiplier is lower in country B.

Answer 2

B) will be less effective in country B than in country A since the value of the tax multiplier is lower in country B.

Step-by-step explanation:

The formula of Tax Multiplier is: -MPC x 1 / MPS

Where MPC is marginal propensity to consume, and MPS is marginal propensity to save.

As can be seen, the marginal propensity to save is the denominator of the formula, which means that a higher MPS value will decrease the overall value of the tax multiplier.

Because the MPS for country B is higher (0.5) than for country A (0.1), the tax multiplier for country B will be lower, making the tax cut policy of the government less effective.