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CA Foundation · Business Economics · Determination of National Income

An economy has a marginal propensity to consume of 0.8 and a proportional income tax rate of 25%. Ignoring imports, what is the value of the government expenditure multiplier?

The multiplier is 2.5. With a proportional income tax, each rupee of income leads to induced consumption of MPC times (1 minus t), which is 0.8 times 0.75, or 0.6. The multiplier is 1 divided by (1 minus 0.6), which equals 2.5.

  1. A2.5Correct
  2. B5
  3. C4
  4. D1.25

Explanation

With proportional tax t, the multiplier = 1/[1 - MPC(1 - t)]. MPC(1 - t) = 0.8 x 0.75 = 0.6, so the multiplier = 1/0.4 = 2.5. Option B (5) wrongly ignores the tax rate.

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