Question

If the marginal propensity to consume (MPC) is \(0.6\), find the value of the tax multiplier.

• A. \(0.25\)
• B. \(-0.25\)
• C. \(1.5\)
• D. \(-1.5\)

Hint:

Tax multiplier is always negative: \[ K_T = \frac{-MPC}{1-MPC} \] The negative sign shows the inverse relationship between taxes and income.

Answer 1

The Correct Option is D

Concept:
Tax multiplier shows the change in national income due to a change in taxes. The formula for tax multiplier is: \[ K_T = \frac{-MPC}{1-MPC} \] where, \[ K_T = \text{Tax multiplier} \] \[ MPC = \text{Marginal Propensity to Consume} \] The tax multiplier is negative because tax and income are inversely related. If taxes increase, disposable income decreases. When disposable income decreases, consumption decreases. As consumption decreases, national income also decreases.

Step 1: Write the given value.
Given: \[ MPC = 0.6 \]

Step 2: Write the formula of tax multiplier.
The formula is: \[ K_T = \frac{-MPC}{1-MPC} \]

Step 3: Substitute the value of MPC.
Putting \(MPC = 0.6\), we get: \[ K_T = \frac{-0.6}{1-0.6} \]

Step 4: Simplify the denominator.
\[ 1 - 0.6 = 0.4 \] So, \[ K_T = \frac{-0.6}{0.4} \]

Step 5: Divide the numerator by the denominator.
\[ \frac{0.6}{0.4} = 1.5 \] Therefore, \[ K_T = -1.5 \]

Step 6: Interpret the result.
The negative sign shows that taxes and income move in opposite directions. If taxes increase, national income decreases. If taxes decrease, national income increases. Therefore, the value of tax multiplier is: \[ \boxed{-1.5} \] Hence, the correct answer is: \[ \boxed{\text{(D)}} \]