Which policy measure would be more successful in stimulating the economy: a $100 billion tax cut...

Which policy measure would be more successful in stimulating the economy: a $100 billion tax cut financed by a $100 billion cut in government purchases, or a temporary tax credit of 10% on each productive investment undertaken next year? Explain your answer.

Expert Solution

A temporary tax credit of 10%, on each productive investment, will be more successful, because it will increase the consumption and output and make positive impact upon the economy. But, in another alternative, decrease in consumption and output due to $100 billion cut in government purchases, will be more than the increase in consumption and subsequent output due to $100 billion tax cut.

Decrease in consumption due to decrease in expenditure = 100*(1/(1-MPC))

Increase in consumption due to decrease in tax = 100*MPC*(1/(1-MPC))

So, net increase in consumption = 100*MPC*(1/(1-MPC)) - 100*(1/(1-MPC))

So, net increase in consumption = (MPC - 1)*(100*(1/(1-MPC))

Here in general, MPC < 1

Then,

(MPC-1) will be negative.

Hence,

(MPC - 1)*(100*(1/(1-MPC)) will be negative.

but, 10% tax credit, will always give positive impact upon the output and consumption. So, this alternative is selected.

Rahul Sunny answered 1 year ago

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