The marginal propensity to consume is 0.8. What will be the value of…

The correct answer is Option (4) → -4

A tax takes away part of people’s income, so they spend less, and through the multiplier equilibrium income falls by more than that first cut. The tax multiplier, −c/(1 − c), is the change in equilibrium income per unit change in taxes; it is negative because a tax cuts disposable income and so consumption.

Given:

• Marginal propensity to consume, c = 0.8

Working it out:

• Tax multiplier = ΔY/ΔT = –c/(1 – c)

• Tax multiplier = –0.8/(1 – 0.8)

• Tax multiplier = –0.8/0.2

• Tax multiplier = –4, which is Option (4)

Its size is smaller than the government expenditure multiplier, 1/(1 – c) = 5, because a tax first changes disposable income and only the fraction c of that change is spent.

Note: A same/similar question was asked in CUET (UG) in the papers below.

* A similar question.