Explain why the tax multiplier is smaller in absolute value than the government expenditure multiplier.
The tax multiplier is smaller in absolute value than the government expenditure multiplier because the government expenditure affects the total expenditure and taxes through the multiplier.
The tax multiplier also influences the disposable income which affects the overall consumption level.
Let us explain it with the help of an example -
Suppose MPC (c) is 0.60
Government expenditure multiplier = 1/1-c
Tax multiplier = - c/1-c
= - 0.6 /1-0.6
= - 1.5
This shows that government expenditure multiplier is more than the tax multiplier.
Suppose that for a particular economy, investment is equal to 200, government purchases are 150, net taxes (that is lump-sum taxes minus transfers) is 100 and consumption is given by C = 100 + 0.75Y (a) What is the level of equilibrium income? (b) Calculate the value of the government expenditure multiplier and the tax multiplier. (c) If government expenditure increases by 200, find the change in equilibrium income.
Consider an economy described by the following functions: C = 20 + 0.80Y, I = 30, G = 50, TR = 100 (a) Find the equilibrium level of income and the autonomous expenditure multiplier in the model. (b) If government expenditure increases by 30, what is the impact on equilibrium income? (c) If a lump-sum tax of 30 is added to pay for the increase in government purchases, how will equilibrium income change?