According to the permanent hypothesis, households will tend to react to a temporary tax cut by:
A. assuming the new tax level will be permanent.
B. saving most of the additional disposable income.
C. increasing consumption sharply in response to the higher disposable income.
D. temporarily increasing their magical propensity to consume
I'm stuck between B and D. any helpp?
Check this article.
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According to the permanent income hypothesis, households will tend to react to a temporary tax cut by
To determine the correct answer between options B and D, you need to understand the concept of the permanent income hypothesis (PIH). The PIH suggests that households base their consumption decisions on their long-term or permanent income, rather than temporary changes in income.
When faced with a temporary tax cut, the PIH states that households will react by assuming that the new tax level is also temporary. Therefore, they will not consider this change in income as a permanent increase, and their consumption behavior will not alter significantly.
Option A refers to assuming the new tax level will be permanent, but the PIH suggests the opposite. Option C states that households will increase consumption sharply, which is inconsistent with the PIH.
Therefore, the correct answer is option B: households will save most of the additional disposable income in response to a temporary tax cut, as they do not view it as a permanent increase in income according to the permanent income hypothesis.