Question

If current output is $40b less than Potential GDP, how much would congress need to decrease taxes by to correct this short-run economic fluctuation given that the MPC is 0.75?

Answer 1

Answer:

Reduction in Tax Needed = $ 13.33

Explanation:

Tax Multiplier shows magnitude of change (decrease) in income due to tax change (rise) .

Tax Multiplier = ΔY / ΔT = - MPC / (1- MPC)

Given : Change in Income needed [ΔY] = 40

MPC = 0.75

Putting in formula ;

40 / ΔT  = - 0.75 / (1- 0.75)

40 / ΔT = - 0.75 / 0.25

40 / ΔT  =  - 3

ΔT = - 40/ 3

ΔT = - 13.33

Answer 2

The congress will need to decrease the taxes by $13.33 billion to correct the short-run economic fluctuation.

Here, we will determine the how much of tax collection need to be reduced to correct the short-run economic.

Given Information

Current output = $40 billion < Potential GDP

MPC = 0.75

The tax multiplier shows the magnitude of changes (decrease) in income because of tax change (rise).

• The Formula of Tax Multiplier = {ΔY / ΔT = - MPC / (1- MPC)}

40 / ΔT  = -0.75 / (1 - 0.75)

40 / ΔT = -0.75 / 0.25

40 / ΔT  =  -3

ΔT = -40/ 3

ΔT = -13.33

So, the congress will need to decrease the taxes by $13.33 billion to correct the short-run economic fluctuation.

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