ECONOMICS
AGGREGATE DEMAND
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Question
[CLICK ON ANY CHOICE TO KNOW THE RIGHT ANSWER]
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Both decrease
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Both increase
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The size of the tax multiplier increases, the size of the spending multiplier decreases
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The size of the tax multiplier doesn’t change, the size of the spending multiplier increases
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The size of the tax multiplier increases, the size of the spending multiplier doesn’t change
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Detailed explanation-1: -Changes in the size of the leakages-a change in the marginal propensity to save, the tax rate, or the marginal propensity to import-will change the size of the multiplier. Thus, the spending multiplier in the real world is less than the multiplier derived in our simple example above.
Detailed explanation-2: -Changes in investment will affect the investment multiplier but not the expenditure multiplier. Since the expenditure multiplier increases as MPC increases in cannot increase when MPC decreases.
Detailed explanation-3: -The magnitude of the multiplier is directly related to the marginal propensity to consume (MPC), which is defined as the proportion of an increase in income that gets spent on consumption. For example, if consumers save 20% of new income and spend the rest, then their MPC would be 0.8 (1-0.2).
Detailed explanation-4: -The tax multiplier has a negative sign, since a decrease in taxes increases consumption, aggregate expenditure, and income, while a tax increase decreases them. The term in brackets is a new multiplier, for the case of a proportional tax.