Question

Macroeconomic

Senate Approves Tax Cut Plarn why? The U.S. Senate has passed legislation to extend the y? Bush-era tax cuts for high-income earners to middle- class Americans earning up to $250,000 per year. Source: The Financial Times, July 26, 2012 t- Fact: Middle and low-income earners spend almost all their disposable incomes. High-income earners save a significant part of their disposable incomes. 9. a. Explain the intended effect of extending tax ow me. cuts to middle-class Americans but not for high-income families. Draw a graph to illus trate the intended effect. te nds. b. Explain why the effect of tax cuts depends on who receives them. 10 IV/hot wotild b

Answer 1

a. Since middle-class Americans have a tendency to spend almost all their disposable income a tax cut would lead to an increase in their disposable income and increase consumption expenditure. This would shift the aggregate demand curve from AD to AD' (outwards) resulting in an increase in the real GDP from Y to Y'.

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b. The effect of the tax cut depends on the relative magnitude of the shift of the aggregate demand curve. This means that the more the consumer expenditure increases, the larger the effect on aggregate demands and thus, real GDP. Since middle class and lower class Americans spend most of their disposable incomes, targeting them would be a more effective policy measure and have a greater impact on real GDP.