NISM Certifications · NISM-Series-XV: Research Analyst · Economic Analysis
An economy has a marginal propensity to consume of 0.75 and the government raises spending by Rs 10,000 crore while simultaneously raising lump-sum taxes by Rs 10,000 crore (no other leakages). What is the net change in equilibrium income?
Equilibrium income rises by Rs 10,000 crore. The spending multiplier of 4 adds Rs 40,000 crore, while the tax multiplier of minus 3 subtracts Rs 30,000 crore. The net effect equals the change in the budget, reflecting the balanced budget multiplier of one.
- ARs 40,000 crore
- BRs 10,000 croreCorrect
- CRs 30,000 crore
- DRs 0
Explanation
Spending multiplier = 1/(1-0.75) = 4, giving +40,000. Tax multiplier = -0.75/0.25 = -3, giving -30,000. Net = +10,000 crore, which equals the balanced budget multiplier of 1. Rs 40,000 ignores the tax; Rs 30,000 counts only the tax effect magnitude; Rs 0 wrongly assumes they cancel.
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