In which of the following situations would the multiplier effect on a country's economy of a tax cut implemented by that country's government be greatest?
A) The country is very open to international trade and imports are high relative to GDP.
B) The country's citizens are affluent and tend to save a relatively high proportion of their income.
C) The country's citizens have relatively low incomes and spend little on foreign holidays or imported goods.
D) The country's citizens are cautious and sceptical, leading them to assume that the tax cut will soon be reversed.

Question

Quizplus · Accepted Answer

The multiplier effect of a tax cut is greater when the recipients of the tax cut spend a larger fraction of their income. In option C, the citizens have low incomes and spend less on foreign holidays or imported goods, so they are likely to spend most of any extra income from the tax cut in the country's domestic economy, thereby boosting the multiplier effect. In contrast, options A and B suggest that some of the extra income may leak out of the domestic economy through imports or savings. Option D refers to the expectations of the citizens, which may affect the timing of the multiplier effect rather than its magnitude.

In Which of the Following Situations Would the Multiplier Effect