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NISM Certifications · NISM-Series-XV: Research Analyst · Economic Analysis

An economy has a marginal propensity to consume of 0.75 and income tax is a lump-sum amount that does not vary with income. The government increases its spending by Rs 40,000 crore, financed fully by an equal rise in lump-sum taxes. Using the simple Keynesian multiplier model, what is the change in equilibrium income?

Income rises by Rs 40,000 crore. The spending multiplier of 4 adds Rs 1,60,000 crore, but the equal lump-sum tax increase with a multiplier of minus 3 subtracts Rs 1,20,000 crore. The net effect equals the spending change, as the balanced budget multiplier is one.

  1. ARs 40,000 croreCorrect
  2. BRs 1,60,000 crore
  3. CRs 1,20,000 crore
  4. DRs 0

Explanation

Balanced budget multiplier: government spending multiplier = 1/(1-0.75) = 4, giving +1,60,000 crore. Tax multiplier = -0.75/0.25 = -3, giving -1,20,000 crore. Net change = 40,000 crore, equal to the spending change (balanced budget multiplier is 1). The 1,60,000 figure ignores the tax effect.

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