A tax reduction of a speciﬁc amount will be more expansionary the
A) smaller is the economy's MPC.
B) larger is the economy's MPC.
C) smaller is the economy's multiplier.
D) less is the economy's built-in stability.

Question

Quizplus · Accepted Answer

The larger the economy's MPC (marginal propensity to consume), the more likely it is that people will spend the additional income from the tax reduction, leading to a larger increase in aggregate demand and a more expansionary effect on the economy. On the other hand, a smaller MPC would mean that people are more likely to save the additional income, leading to a smaller increase in aggregate demand and a less expansionary effect on the economy. The multiplier effect (the amount by which GDP increases relative to the initial increase in spending) is directly related to the MPC, so a smaller multiplier would mean a smaller increase in GDP. Built-in stability refers to the automatic stabilizers in an economy (such as unemployment insurance and progressive income taxes), which tend to moderate fluctuations in economic activity. A less stable economy would be more vulnerable to economic shocks, but this is not directly related to the effect of a tax reduction on aggregate demand.

A Tax Reduction of a Speciﬁc Amount Will Be More