Question

explain why the marginal propensity to consume out of a temporary tax rebate would be lower than for a permanent rebate.

Answer 1

Answer

The consumer's spending or consumption expenditure depends on the present income and expected future income.When a consumer takes decision about consumption, she responds more to her expected permanent income than to a temporary income. If a consumer expects that in future she will permanently earn more than what she is earning now, she will be then confident to increase her consumption level at present. Thus her marginal propensity to consume rises because she anticipates a higher permanent income in future.

The temporary tax rebate temporarily affects the income. If the tax rebate is temporary, the consumer will temporarily enjoy a rise in disposable income.A rational consumer may not like to increase her consumption spending based on temporary tax rebate, rather she would like to save it.

When the tax rebate is permanent, the consumer becomes confident about her expectation on future income. The permanent tax rebate increases consumer's permanent disposable income. Thus, the consumer becomes confident to increase her consumption expenditure. As a result, the consumption expenditure rises with the permanent tax rebate.

Thus,  the marginal propensity to consume out of a temporary tax rebate would be lower than for a permanent tax rebate.

_________________________________________________________