If the absolute value of the tax multiplier equals 1.6, real GDP is $1.3 trillion, and potential real GDP is $1.34 trillion, then taxes would need to be cut by ________ to restore the economy to potential real GDP.

Question

Quizplus · Accepted Answer

The tax multiplier is the change in real GDP divided by the change in taxes. If the absolute value of the tax multiplier is 1.6, then a $1 change in taxes leads to a $1.6 change in real GDP. To restore the economy to potential real GDP of $1.34 trillion from the current level of $1.3 trillion, we need to increase real GDP by $0.04 trillion ($1.34 trillion - $1.3 trillion). Using the tax multiplier, we can find the required change in taxes:

$0.04 trillion = 1.6 x change in taxes

Change in taxes = $0.04 trillion /1.6 = $0.025 trillion = $25 billion

Therefore, taxes would need to be cut by $25 billion to restore the economy to potential real GDP.

If the Absolute Value of the Tax Multiplier Equals 1