Answer to Question #153801 in Macroeconomics for Sandali

Question

Explain carefully why the tax multiplier [ΔY/ ΔT = -b/ (1-b)] is negative and why it is  smaller in absolute value than the government expenditure multiplier [ΔY/ ΔG = 1/ (1- b)].

Answer 1

Solution:

This is the case because the tax multiplier has a negative sign due to the negative magnitude or lesser impact it has on the economy.

For example, when the government cuts taxes income may increase, however not every one of that income will be spent in the economy because some of it may be saved.

However, a change in government purchases will have a positive impact as well as a larger effect on the economy than a mere change in the tax multiplier.

In summary, the tax multiplier is different from the government purchases multiplier, in both sign and relative magnitude because of the varying degrees of their usage.