Suppose the MPC is08 and the current tax rate is 25%. Specify all answers to two

Question

Suppose the MPC is08 and the current tax rate is 25%. Specify all answers to two decimal places. What is the government purchases multiplier? Number If the tax rate increases to 35%, all else remaining equal, what is the government purchases multiplier? Number Choose the answer that best describes the relationship between the changes in the tax rate and the government purchases multiplier, assuming all else remains equal ° O O Increases in the tax rate decrease the government purchases multiplier. Increases in the tax rate increase the government purchases multiplier The government purchases multiplier is not affected by the tax rate.

Explanation / Answer

Government purchases multiplier = 1/1 - MPC (1 - t). Here MPC = 0.8 and tax rate t = 0.25. Then we have GPM = 1/1 - 0.8(1 - 0.25) = 2.5

Now tax rate is 35%. Government purchases multiplier = 1/1 - MPC (1 - t). Here MPC = 0.8 and tax rate t = 0.35. Then we have GPM = 1/1 - 0.8(1 - 0.35) = 2.08333 = 2.083

From the above results, we find that an increase in marginal tax rate reduces the government spending multiplier. First option is correct

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