I just need a little help on a few questions:
- Why does a tax cut have a smaller multiplier than a hike in government spending if its the same amount?
- Federal tax drops from 20 to 30 percent. Due to that income increases from 600BLN to 800BLN, logical explaination is that workers have increased their work efforts. Would this be a movement along the downward sloping or upward sloping Laffer Curve? Why?
- Explain the theory that crowding out can weaken our nullify the effect of expansionary fiscal policy finaced by federal government borrowing.
1) Because of the first round effects. Initially, a $100 of government spending raises GNP by $100. (Y=C+I+G). However with taxes, with a $100 decrease in taxes, some goes into consumption, some to savings. We assume that consumption increases by mpc*100 and savings by (1.-mpc)*100.
2) "Federal tax DROPS from 20 to 30 percent" Hmmmmmm, did you mean from 30 to 20 percent? In that case, you would be on the upward slopint, left-of-peak portion of the Laffer Curve.
3) When govt borrows, demand for loanable fund rises (government uses a larger portion of the pool of loanable money), which causes interest rates to rise, causing private investment to fall. Government spending crowded out private investment.
Sure, let me explain each question in detail:
1) Why does a tax cut have a smaller multiplier than a hike in government spending if it's the same amount?
The multiplier effect refers to the increase in national income resulting from an initial injection of spending or investment into the economy. The multiplier differs between a tax cut and government spending because of how they impact aggregate demand.
When the government increases spending by $100, the full $100 is injected directly into the economy, leading to a $100 increase in national income. This is because the initial spending creates a chain reaction of additional spending as people and businesses receive income and spend it themselves.
However, with a tax cut, not the full amount of the tax cut is immediately spent. Instead, a portion is saved or used to pay off debt. The marginal propensity to consume (mpc) represents the proportion of additional income that is spent rather than saved. So, if the mpc is 0.8 (80%), then a $100 tax cut would result in an increase in consumption of $80 (0.8 * $100), while the remaining $20 would be saved or used for debt repayment.
Due to these differences in spending patterns, a tax cut has a smaller multiplier effect compared to government spending. In this case, the tax cut would have a multiplier of mpc * 100, resulting in a $80 increase in national income compared to the $100 increase from government spending.
2) Federal tax drops from 20 to 30 percent. Due to that, income increases from 600BLN to 800BLN. Would this be a movement along the downward sloping or upward sloping Laffer Curve? Why?
In this scenario, if the federal tax drops from 30 to 20 percent and income increases from 600BLN to 800BLN, this would represent a movement along the downward-sloping Laffer Curve.
The Laffer Curve is a graphical representation of the relationship between tax rates and tax revenue. It suggests that there is an optimal tax rate that maximizes revenue. When the tax rate is too high, reducing it can stimulate economic activity and result in higher tax revenue.
In this case, as the tax rate decreased, individuals and businesses were incentivized to increase their work efforts, which would lead to higher income. This suggests that tax cuts can have positive effects on economic growth and revenue collection by encouraging productivity.
3) Explain the theory that crowding out can weaken or nullify the effect of expansionary fiscal policy financed by federal government borrowing.
Crowding out is a theory that explains how government borrowing can impact private investment and limit the effectiveness of expansionary fiscal policy. When the government borrows money to finance its spending, it competes with the private sector for available funds in the loanable funds market.
As the government borrows, the demand for loanable funds increases, causing interest rates to rise. Higher interest rates make it more expensive for businesses and individuals to borrow money, reducing their ability and willingness to invest in projects. This decrease in private investment can weaken or nullify the expansionary effects of government spending.
In other words, when the government borrows heavily to finance its spending, it absorbs a significant portion of available funds, leaving less capital for private investment. This reduces the overall impact of expansionary fiscal policy as the increase in government spending is partially offset by the decrease in private sector investment.
It's important to note that the theory of crowding out is not universally accepted, as there are different views on the extent and timing of its effects. However, it is a commonly discussed concept when analyzing the impact of government borrowing on the economy.
I hope these explanations help! Let me know if you have any further questions.