Answer to Question #225089 in Macroeconomics for Neema

Question

4. Why do we call mechanisms such as proportional income taxes and the welfare system auto-

matic stabilizers ? Choose one of these mechanisms and explain carefully how and why it 

affects fluctuations in output.

Answer 1

Solution:

Mechanisms such as proportional income taxes and the welfare system are called automatic stabilizers since they act to stabilize economic cycles and are automatically activated without additional government intervention.

Automatic stabilizers are a type of fiscal policy designed to neutralize fluctuations in a country’s economic activity through their normal operation without direct involvement by the government or policymakers.

The best well-known automatic stabilizers are the progressive graduated corporate and personal income taxes. This involves the use of a progressive taxation structure under which the share of income generated in taxes is higher when incomes are high and lower when incomes fall due to a recession, weakening investments, or job losses. It is meant to stabilize incomes, consumption levels, and business spending.