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Explain the effect of a discretionary cut in taxes of $50 billion on the economy when the economy's marginal propensity to consume is 0.9. How does this discretionary fiscal policy differ from a discretionary increase in government spending of $40 billion dollars?

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Answer:

Explanation:

Fiscal policy is the use of government spending and taxation to influence the economy. Governments use fiscal policy to influence the level of aggregate demand in the economy in an effort to achieve the economic objectives of price stability, full employment, and economic growth.

The government has two levers when setting fiscal policy:

Change the level and composition of taxation, and/or

Change the level of spending in various sectors of the economy.

There are three main types of fiscal policy:

Neutral: This type of policy is usually undertaken when an economy is in equilibrium. In this instance, government spending is fully funded by tax revenue, which has a neutral effect on the level of economic activity.

Expansionary: This type of policy is usually undertaken during recessions to increase the level of economic activity. In this instance, the government spends more money than it collects in taxes.

Contractionary: This type of policy is undertaken to pay down government debt and to cap inflation. In this case, government spending is lower than tax revenue.

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