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IAI Actuarial Core Principles · Business Economics · Impact of macroeconomic policies on businesses

An economy has a marginal propensity to consume out of disposable income of 0.75 and no taxes on income, imports or savings leakages other than saving. The government increases its spending on infrastructure by ₹2,000 crore, with no change in taxes. Using the simple Keynesian multiplier, what is the total increase in national income?

National income rises by ₹8,000 crore. With an MPC of 0.75 the simple spending multiplier is 1 divided by 0.25, which equals 4, and four times the ₹2,000 crore injection gives ₹8,000 crore of additional national income.

  1. A₹2,000 crore
  2. B₹6,000 crore
  3. C₹8,000 croreCorrect
  4. D₹10,000 crore
  5. ₹1,500 crore

Explanation

The simple multiplier is 1/(1 - MPC) = 1/0.25 = 4. The income rise is 4 x ₹2,000 crore = ₹8,000 crore. The figure ₹6,000 crore comes from using MPC/(1 - MPC) = 3, which is the tax-multiplier style formula and is wrong for a government spending change.

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