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Consider two policies $-$ a tax cut that will last for only one year and a tax cut that is expected to be permanent. Which policy will stimulate greater spending by consumers? Which policy will have the greater impact on aggregate demand? Explain.
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Chapter 34
The Influence of Monetary and Fiscal Policy on Aggregate Demand
The Real Economy in the Long Run
Money and Prices in the Long Run
Short-Run Economic Fluctuations
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in question, for we're being asked to consider two policies. A tax cut that were less for only one year and the tax cut that is expected to be permanent. Which policy will stimulate it? Grated spending by consumers and which policy will have the greater impact on a great demand? Well, this is a rather simple question. And to answer it, let's consider very simple and concrete example. Imagine that you're earning a monthly salary of, let's say, $3,000 and on average, you're disposable income is, let's say, eight eighteen $1,800. Alright, so under the new tax cut, your new disposable income will be $2,000. That's an increase of $200 per month. So for this year, your disposal Lincoln would be $2,000. But because the government tech side will be affected for one here only from next year onwards your disposable income goes back to normal, which is $1,800. So from your perspective was a consumer. The expected increase in disposable income will be quote 200 per month, times 12 months, times only one a year. Yeah, which is equal to 24 $100. Well, that's not too bad. You can use this extra money to buy some new clothes going trip on buying a guitar, and so this will definitely stimulate a great demand. Buy a certain amount. Now let's consider the same case. But under a parent tax cuts. So the government announces reduction in tax rates that would less indefinitely, maybe for 10 years. 10 2030 you name it. So from now on, you're disposable. Income will be 2,000. No, just for this year, but for every year for the next 11 after and so on and so forth. So in this case, from your perspective as a consumer, the expected increase in disposable income will be equal to 200 per month times 12 months, times any number of years. Let's say 10 years. Ahh. And this will be equal to $24,000 more, not just 2,400 right? If the increase is expected to last for more than 10 years, there would be 48,000 or 72. You name it, but we're talking about an increase that is larger by orders of magnitude than the other one. So what gonna happen with this? X amount of money you're not only gonna buy, it's hard. You can buy a new car, you can rent it by your house. So this will definitely increase government spending and stimulate agreement aggregate demand by even more. So the sum of we can say that a tax cut that experiment will have a bigger impact on consumer spending and agree demand because consumers will view it as adding substantially to their financial resource is and they will increase their spending substantially. On the other hand, if the text got his temporary, consumers will view it as adding just a little bit to their financial resource is, so they will not increase spending as much.
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