Question

An increase in taxes of a specific amount will have a smaller impact on the equilibrium GDP than will a decline in government spending of the same amount because:

- disposable income will fall by some amount smaller than the tax increase.
- declines in government spending always tend to stimulate private investment.
- some of the tax increase will be paid out of income that would otherwise have been saved.
- the MPC is smaller in the private sector than it is in the public sector.

Answer 1

Answer:

Some of the tax increase will be paid out of income that would otherwise have been saved.

Explanation:

Increase in taxes and decrease in government expenditure are both fiscal policy tools that is contractionary in nature.

Increase in taxes affect disposable income because disposable income is income minus taxes, if the increase in taxes is not allowed to affect current consumption, and if it is charged to savings, then it will not have too much effect on the equilibrium GDP. But decline in government spending will have a higher impact on GDP because nothing will shield its direct impact on the GDP.