Question

Analyzing Effects Tom, Cia, and Julie were all in the 50 percent tax bracket. When a tax cut program reduced their tax bracket to 28 percent, they all made changes in their lives. Tom decided to work fewer hours so he could begin training to run in a marathon. Cia bought the new sports car she'd been wanting. Julie chose to work more hours so she could save extra money for her daughter's college education. Explain the effects of the tax cut for each individual. Use supply-side or demand-side economics reasoning in your answer.

Short answer

Tom used the tax cut for personal goals, Cia for consumer spending, and Julie worked more due to financial incentive.

Step-by-step solution

Understanding Supply-Side Economics

Supply-side economics focuses on the impact of tax cuts on producers and businesses. The theory suggests that lower taxes increase the amount of money that people have to spend, invest, or work. In this context, a tax cut is supposed to incentivize individuals to work more and invest in ways that boost economic output.

Considering Demand-Side Economics

Demand-side economics emphasizes the importance of demand in economic growth. According to this theory, tax cuts can enhance consumer spending, as individuals have more disposable income, thus stimulating demand for goods and services.

Analyzing Tom's Decision

Tom opted to work fewer hours and focus on training instead of earning more income. From a supply-side perspective, although the tax cut increased his disposable income, it also provided him with financial flexibility to pursue personal goals without the immediate need for additional income.

Analyzing Cia's Decision

Cia decided to purchase a new sports car. This action reflects demand-side economics because the tax cut provided her with additional disposable income, enabling her to make consumer purchases she otherwise might have postponed, thus stimulating demand in the economy.

Analyzing Julie's Decision

Julie chose to work more hours to save extra money for her daughter’s education. This decision aligns with supply-side economics as the tax cut incentivized her to increase her work hours, boosting her income and resulting in a higher supply of labor.

Key concepts

Supply-Side Economics

Supply-side economics is a theory that focuses on how reducing taxes can encourage people to produce more goods and services. The idea is that lower taxes leave individuals and companies with more money in their pockets. This extra money can then be reinvested in various activities that could increase production. For example, a person might choose to work more because they keep more of their earnings or a business might use the saved tax money to expand its operations.

In the context of the exercise, Julie's decision reflects supply-side economics. By working more hours, she is effectively increasing her productivity. She is supplying more labor in exchange for higher income, which she can save or spend on something important like her daughter's education. The tax cut incentivized her action, as she would take home a larger portion of her earnings as taxes have decreased.

Demand-Side Economics

Demand-side economics, on the other hand, highlights the importance of consumer demand in driving economic growth. When people spend more money, businesses see increased demand for their products and services. This usually leads to more production and potentially more jobs.

In this exercise, Cia's decision to buy a new sports car follows demand-side economics. By using her additional disposable income from the tax cut to purchase a car, she contributes to the demand for goods like automobiles. This kind of consumer spending is crucial for economic activity because it kickstarts a cycle where businesses need to produce more to meet increased demand. As demand grows, it can lead to higher production levels and sometimes an increase in labor needed.

Economic Incentives

Economic incentives are motivations that drive behavior in economic contexts. These are often financial rewards or penalties that encourage people to engage in certain activities. Tax cuts are a form of financial incentive. They offer people the chance to keep a larger portion of their earnings, which can motivate different behaviors depending on individual circumstances and preferences.

In the original exercise, different individuals responded to the tax cuts with varied actions. For example, Tom felt economically secure enough to reduce his working hours and focus on personal development, like running marathons. This reflects the dual nature of incentives, where the same economic change (tax cut) can lead to different behaviors based on personal goals and circumstances.

Disposable Income

Disposable income is the amount of money a person has left to spend or save after taxes are deducted. It is crucial in determining a person’s capacity to spend on needs and wants and affects overall economic demand.

In the scenario from the exercise, the tax cut increased the disposable income for Tom, Cia, and Julie. Tom used his increased disposable income for more personal freedom, opting to train for a marathon. Cia chose to spend hers on a new car, thus stimulating demand in the economy. Meanwhile, Julie decided to increase her work hours, using her higher income to save more for future expenses, reflecting individual differences in handling disposable income.