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    Effect of tax rate changes

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    Dear OTA: Help needed with the following:

    *Please identify and describe the effect of changing the tax rate on disposable income and consumption, as well as the post-tax multiplier.

    *Please describe the likely changes to equilibrium output and price levels resulting from the change in the tax rates. Begin by describing the effects on aggregate supply and/or demand to fully demonstrate the connection between the tax rate change and equilibrium.

    *Please describe the change in tax revenues for the government in the new equilibrium, in both the short and longer terms

    Overall, please assume that overall taxes are cut by 10 percent across the board. What will this change do to disposable income, consumption, and the multiplier? What's likely to happen to equilibrium output and prices? How will the tax cut affect government revenues in the new equilibrium?
    Thank you!

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    Solution Preview

    Because disposable income equals real GDP less net taxes, any change in the tax rate will have a direct affect on disposable income. Consumption comprises immediate purchases of goods and services. It is considered of vital importance become it keeps people employed. For every dollar of income received, some if it is spent and some is saved. We express this as a percentage, the marginal propensity to consume, or MPC. It is the change in consumption spending divided by the change in real disposable income. 1-MPC is therefore the marginal propensity to save, as any income not spent is considered saved.

    The tax multiplier reflects a change in taxation impacts GDP, and is calculated as -MPC/MPS = -(1-MPS)/MPS.). Its absolute value is always one less than the simple multiplier and it is always negative. A reduction in taxes would be also ...

    Solution Summary

    Effect of tax rate changes on disposable income and consumption.