Suppose the government proposes a tax cut of $100 million to stimulate the econo

Question

Suppose the government proposes a tax cut of $100 million to stimulate the economy. Economists predict that people will spend 90% of their rebate (extra income) and save 10%. Thus, of the extra income generated by the tax cut, $100(0.9) million would be spent and so become extra income to somebody else. Assume that these people spend 90% of their extra income and that this continues ON AND ON. Caculate the total additional spending created by such a tax cut.

a)additional spending =__________

The above assumptions were made during "good" times when people spent extra income wildly and saved very little. Calculate the total additional spending if people spend 70% of their rebate and save 30%

b) additional spending=__________

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Explanation / Answer

additional spending= (90+0.9*90+0.9^2*90+0.9^3*90+......)million hence this is an infinite geometric series therefore the sum of the series will be 90/1-0.9=90/0,1=$900 million when the consumption is 70% then a similar infinite geometric sum will be created with multiplication factor=0.7 therefore the additional spending in this case would be 90/1-0.7= $300million

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