The demand-side effect of a change in taxes is less than the same sized change in government expenditure because
A) the amount by which taxes change is affected by the MPC.
B) only part of the increase in disposable income from the tax cut is spent.
C) changes in government expenditure do not directly affect consumption.
D) tax rates are the same regardless of income levels.

Question

Quizplus · Accepted Answer

When there is a change in taxes (such as a tax cut), not all of the increase in disposable income will be spent, as some people may choose to save the extra money. This is known as the marginal propensity to consume (MPC), and it is typically less than 1. In contrast, a change in government expenditure directly affects consumption (as well as investment and net exports), so the demand-side effect of a change in government expenditure is greater than the same sized change in taxes.

The Demand-Side Effect of a Change in Taxes Is Less