49.) Cassiopeia is a country facing an acute financial crisis. Coupled with a ne

Question

49.) Cassiopeia is a country facing an acute financial crisis. Coupled with a negative growth rate, the rate of inflation in the economy has increased to almost 12 percent. The government of Cassiopeia has recently appointed a panel of experts to suggest suitable fiscal measures. Ronald Boyle, a member of the National Trade Union in Cassiopeia, feels that the best policy on the part of the government would be to announce an income tax rebate in the current year. However, Danny Cox, an economist, feels that income tax rebates will only reduce government revenue. According to him, a substantial increase in aggregate demand can only result from government investment in real assets.

While claiming that a tax rebate in the current year will help in increasing consumption and income in the long run, Ronald is ignoring the fact that:

A. the average income level usually declines during a recession.

B. consumption is determined by real income and not nominal income.

C. the impact of a tax rebate is restricted to current income.

D. the propensity to save by households declines during periods of high inflation.

E. marginal propensity to consume is usually less than one.

Explanation / Answer

C. the impact of a tax rebate is restricted to current income.. During the times of inflation, the price level rise , so real income fall. This reduces the actual consumer spending. Also, the effects of rebate will be realised in current period only and will not be carried out in the long run.

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