A tax cut shifts the aggregate demand curve the farthest if a. the MPC is large and if the tax cut is permanent. b. the MPC is small and if the tax cut is permanent. c. the MPC is small and if the tax cut is temporary. d. the MPC is large and if the tax cut is temporary.

Question

Enrique Abbott

Business

26 July, 06:47

A tax cut shifts the aggregate demand curve the farthest if a. the MPC is large and if the tax cut is permanent. b. the MPC is small and if the tax cut is permanent. c. the MPC is small and if the tax cut is temporary. d. the MPC is large and if the tax cut is temporary.

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Answers (1)

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Porter Case · Answer 1

Answer: the correct answer is a. the MPC is large and if the tax cut is permanent.

Explanation:

MPC stands for the Marginal propensity to consume. In economics, the marginal propensity to consume (MPC) is a metric that quantifies induced consumption, the concept that the increase in personal consumer spending (consumption) occurs with an increase in disposable income (income after taxes and transfers). The equation for aggregate demand proposed by the Mundell-Fleming model of a large open economy is Y = C (Y - T) + I (r) + G + NX (e). Y represents income or output. C (Y - T) represents consumption as a function of disposable income, defined as income less taxes

The former formulas are going to be useful in explaining the argument. Let's say that there is tax cut in this economy of many shopaholics. In this society individuals love shopping (their marginal propension to consume is high) so it means that the tax cut is going to impulse the aggregate demand because the shopaholics are going to have more income (the tax cut gives them more income) to spend on clothing, restaurants, etc as you can see in the formula of aggregate demand, the first component is Consumption, so consumption will push aggregate demand. This tax cut has to be permanent otherwise the aggregate demand will return to the former level.