Question

All else equal, how would an increase in the tax rate affect the government purchases multiplier? It increases the multiplier only if the marginal propensity to consume ( M P C ) is greater than the tax rate. It increases the multiplier only if the marginal propensity to consume ( M P C ) is less than the tax rate. It decreases the government purchases multiplier. It increases the government purchases multiplier. It has no effect.

Answer 1

Answer: It decreases the government purchases multiplier.

Explanation: The Government purchases multiplier is the factor by which the income in an economy increases due to government spending. For example if the government introduces $2 miilion into the economy through projects, the total effect on the economy is more than $2 million, it is multiplied through the contractors, their employees, the businesses the employees patronize and so on.

However, an increase in tax rate has the opposite effect on income, it reduces both the Marginal Propensity to Save and Marginal Propensity to consume. An increase in tax rate will reduce the multiplier.

A tax rate increase is a contractionary measure, that it, it reduces the aggregate demand while increased government spending is an expansionary measure, it increases the aggregate demand.