For a marginal propensity to consume of 0.9, the multiplier effect of an increase of $100 billion in government purchases of goods and services is larger than the multiplier effect of a tax cut of $100 billion because:
A)the government pays a higher price than households for the same goods and services.
B)production of the goods and services the government purchases has a bigger impact on real GDP than production of consumer goods.
C)many households fail to file their income tax and claim their refund.
D)in the first round of spending only $90 billion of the tax cut will be spent and $10 billion will be saved, while the entire $100 billion of government purchases will be spent.

Question

Quizplus · Accepted Answer

The multiplier effect of government purchases is likely to be larger because the entire amount is spent in the first round, leading to more direct and immediate injection of funds into the economy, while with a tax cut, some households may save a portion of the money instead of immediately spending it, leading to a smaller initial increase in aggregate demand and a smaller multiplier effect. A marginal propensity to consume of 0.9 means that for every additional dollar of income, households are likely to spend 90 cents, suggesting that consumption may not be as responsive to tax cuts as government spending on goods and services. The other options (A, B, and C) are not relevant to explaining why the multiplier effect of government purchases is larger than that of a tax cut.

For a Marginal Propensity to Consume of 0