The permanent income hypothesis implies that the effect of a temporary tax cut on economic activity
A) is greater than the effect of a permanent tax cut.
B) is the same as the effect of a permanent tax cut.
C) can be greater than or smaller than the effect of a permanent tax cut, depending on how the tax cut affects the government.
D) is smaller than the effect of a permanent tax cut.

Question

Quizplus · Accepted Answer

The permanent income hypothesis states that people base their consumption on their expected long-term income rather than their current income. Therefore, a temporary tax cut may have a smaller effect on economic activity because it does not significantly change people's long-term income expectations. On the other hand, a permanent tax cut may lead to higher long-term income expectations and, therefore, a greater effect on economic activity.

The Permanent Income Hypothesis Implies That the Effect of a Temporary