Year Consumption Disposable Spending Income (DI) 1991 1,200 1,500 1992 1,440 1,8
ID: 1225178 • Letter: Y
Question
Year Consumption Disposable
Spending Income (DI)
1991 1,200 1,500
1992 1,440 1,800
1993 1,680 2,100
1994 1,920 2,400
1995 2,160 2,700
In 1995, several tax bills were debated in Congress that would have provided greater tax incentives for saving. (None were enacted.) If such saving incentives had been enacted, and had been successful, how would the consumption function have shifted?
Explain why permanent tax cuts are likely to lead to bigger increases in consumer spending than are temporary tax cuts.
Explanation / Answer
(1) If greater tax incentive is offered for saving purpose, then marginal propensity to save will increase, and marginal propensity to consume (MPC) will decrease. As MPC decreases, autonomous consumption component remaining unchanged, the vertical intercept of consumption function will remain unchanged, but the consumption line will rotate downward, reflecting lower dollar amount of consumption for every additional dollar of disposable income.
(2) If tax cut is temporary, even though current disposable income rises, the disposable income in future falls once the tax cut is reversed. So rational consumers will consume less now, keeping aside savings for future when disposable income falls. In contrast, if tax cut is permanent, the increase in disposable income is permanent ceteris paribus. Therefore, consumers raise their consumption demand much more higher than what they do in the case of a temporary tax cut.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.