Could someone please help me understand this? Assume the price level is fixed. W

Question

Could someone please help me understand this? Assume the price level is fixed.

When the government increases taxes (say by 10) it effects consumption indirectly through disposable income. Consumers will save some of it depending on the mpc (let's say .9). Therefore, the change in the AE's autonomous expenditure is 9 (10*.9).

On the other hand, if the government increases taxes by 10, using the same logic, AE's autonomous expenditure will decreases by 9. But how can you explain this is words? We can't say consumers are going to save a portion of the 10 taxes because you can't save something that is being taken away from you. Why does the autonomous expenditure decrease by a fraction of the tax in this case? I understand the math but not the logic. Thanks!!

Explanation / Answer

In the first part, I assume you mean that the government decreases taxes. The consumer's income effectively increases by the amount of the tax decrease. The MPC shows how much of this income increase they will spend. If the tax decreases by 10, then their income increases by 10, and with an mpc of .9, this will mean that they are spending 9 of that 10 increase. To make sense of what happens in the event of a tax increase think of their total income. They have two things they can do with the money, spend it, or save it. If they suddenly have less money (because of a tax increase), they will have to cut their spending, or saving. If they make 10 less, that's 10 that they can't spend or save. With an mpc of .9, that means that they will reduce spending by 9 because of the tax, and the other 1 will be a reduction in their savings.

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