The tax multiplier is used to determine how a change in taxes in an economy impacts Real GDP.
Tax multiplier = -MPC / MPSv
Scenario: Given that in Country ABC the marginal propensity to save is 0.40, calculate and interpret the tax multiplier.
MPSv = 0.40
MPC = 1 - 0.40 = 0.60
Tax multiplier = -0.60 / 0.40
Tax multiplier = -1.5
Answer: For every $1 increase in taxes, Real GDP decreases by $1.50.
Scenario: Country ABC increases their taxes by $100. Given an MPC value of 0.75, how much will this change in taxes decrease the Real GDP?
Change in Real GDP = Tax Multiplier x Change in Taxes
Change in Taxes = $100
MPC = 0.75
MPSv = 1 - 0.75 = 0.25
Tax multiplier = -0.75 / 0.25
Tax multiplier = -3
Change in Real GDP = -3 x $100
Change in Real GDP = -$300
Answer: The government increasing taxes by $100 results in the Real GDP decreasing by $300.
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