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United States (325,774)
Economics (157)
ECON 0110 (84)
Lecture

Section 20 Notes.doc

2 Pages
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Department
Economics
Course Code
ECON 0110
Professor
K E N K E L

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SECTION 20: HOW INCOME TAXES AFFECT THE MULTIPLIER Suppose the mpc = .75 Suppose we consider an economy without taxes. Suppose autonomous spending increases by $100. The successive increases in output and consumption spending will be Round 1: $100 Round 2: $100 x .75 = $75 Round 3: $100 x .75 x .75 = $100 x (.75) = $56.25 Round 4: $100 x (.75) = $42.19 4 Round 5: $100 x (.75) = $31.64 And so forth The sum = $100 x [1/1-.75)] Now consider the same economy with an income tax of, say, 20%. Suppose autonomous spending increases by $100. The successive increases in output will be as follows: Round 1: $100 Because there is a 20% tax, in round 2, the worker who earned $100 only has $80 of disposable income. Given an mpc of .75, the worker spends 75% of the $80. This yields new spending, and new output of $60. Round 2: $100 x (1 - .20) x .75 = $100 x .60 = $60 Round 3: $100 x (1 - .202 x .75 x (1 - .20) x .75 = $100 x (.60) = $36 Round 4: $100 x (.60) = $21.60 Round 5: $100 x (.60) = $12.96 The sum = $100 x [1/1-.60)] = $100 x [1/(1 - .75{1 - .20})] COMPARISON OF THE MULTIPLIER EFFECT WITH AND WITHOUT TAXES mpc = .75 mpc = .75; tax rate = .20 Round 1: $100 .00 $100.00 Round 2: $ 75.00 $ 60.00 Round 3: $ 56.25 $ 36.00 Round 4: $ 42.19 $ 21.60 Round 5: $ 31.64
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