Consider a macro model with a constant price level and demand -determined output. A rise in the net tax rate
The simple multiplier and equilibrium national income.
A) lowers; has no effect on
B) lowers; lowers
C) lowers; raises
D) raises; raises
E) raises; has no effect on

Question

Quizplus · Accepted Answer

A rise in the net tax rate decreases disposable income, which in turn reduces consumption expenditure. This leads to a decrease in aggregate demand and a fall in equilibrium national income. The simple multiplier, which measures the increase in equilibrium national income resulting from an increase in one of the components of aggregate demand, is given by 1/(1-MPC), where MPC is the marginal propensity to consume. Since the rise in net tax rate reduces disposable income and hence consumption expenditure, the MPC falls, resulting in a lower value of the multiplier. Therefore, the simple multiplier declines, amplifying the negative impact of the rise in net tax rate on equilibrium national income.

Consider a Macro Model with a Constant Price Level and Demand