IAI Actuarial Core Principles · Business Economics · Impact of macroeconomic policies on businesses
An economy has a marginal propensity to consume of 0.8, a marginal tax rate of 25% on income, and a marginal propensity to import of 0.1. The government raises spending by ₹600 crore. What is the resulting increase in national income?
National income rises by ₹1,200 crore. Induced domestic spending per rupee of income is 0.8 x 0.75 - 0.1 = 0.5, so the multiplier is 1/0.5 = 2, and 2 x ₹600 crore gives the increase. Ignoring imports would wrongly give ₹1,500 crore.
- A₹1,200 croreCorrect
- B₹1,500 crore
- C₹2,400 crore
- D₹3,000 crore
- ₹3,600 crore
Explanation
Marginal propensity to spend domestically = 0.8 x (1-0.25) - wait, imports must also be removed: 0.8x0.75=0.6, less 0.1 gives 0.5. Multiplier = 1/(1-0.5)=2. Income rise = 2 x 600 = ₹1,200 crore. Using 1/(1-0.6)=2.5 ignores imports and gives ₹1,500 crore.
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