CHAPTER 17 SUMMARY: 1. How might a permanent tax cut lead to an economic recovery, but a temporary tax cut do very little for the economy? According to the life-cycle theory of consumption, people's spending patterns are determined more by their permanent rather than their current income. A permanent tax cut will increase people's permanent after-tax income and, as a result, increase consumption. A temporary tax cut, on the other hand, will not significantly alter people's permanent income and, therefore, will not elicit an increase in consumption spending. 2. How could people be worse off after a pay increase? The labor supply decision involves households deciding whether, and how much, to work. This depends on, among other factors, the wage rate. There is an important distinction, however, between real and nominal wages. Nominal wages are wages paid in current dollars. Real wages, on the other hand, take into account the effects of inflation. If inflation increases faster than nominal wages, real wages decline. Thus, although people will nominally be getting higher
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