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Question
Explain why the tax multiplier is smaller in absolute value than the government expenditure multiplier.
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Solution
The tax multiplier is smaller in absolute value than the government expenditure multiplier, as the government expenditure affects the total expenditure and taxes through the multiplier. Tax multiplier also influences disposable income that affects the overall consumption level.
The reason is explained through the following example.
Let’s assume MPC be to 0.80.
Then, the government expenditure multiplier `=1/(1-c)`
`=1/(1-0.80)`
`=1/0.20=5`
Tax multiplier `=(-c)/(1-c)=(-0.80)/(1-0.80)`
`=(-0.80)/0.20=-4`
This shows that government expenditure multiplier is more than tax multiplier.
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