Question

1. From the perspective of someone using aggregate-demand and aggregate supply analysis, what is the impact of a tax cut when the economy is operating above full employment. Is this a wise policy? Why or why not?

2. From your readings, what is meant by each of the following?

a) MPC

b) MPS

3. Explain briefly how spending can multiply, and then calculate the spending multiplier when the MPC is
a. 0.75   
b. 0.8       
c. 0.6    

pleas answer them by typing

Answer 1

Ans.1- If the economy is operating above full employment it means output produced is above the potential output level. A tax cut will further shift the AD curve to the right and hence equilibrium output will further increase . So,this policy is not a wise policy . Instead,tax should be raised.

Ans.2- MPC - it is the change in consumption per unit change in income . (mpc = marginal propensity to consume)

MPS - It is the change in saving per unit change in income.(MPS= marginal propensity to save)

Ans.3 - When people get money, they spend that money or save it. When they spend it on something, that means somebody else is getting money. Then that person spends money somewhere which means now somebody else is getting money. This process is repeated over and over expanding the income in our economy.

Spending multiplier =1/1-MPC

(a) spending multiplier = 1/1-0.75 = 1/0.25= 4

(b) spending multiplier= 1/1-0.8 = 1/0.2 = 5

(c) spending multiplier = 1/1-0.6= 1/0.4= 2.5

If you have any doubt feel free to ask.