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CA Foundation · Business Economics · Determination of National Income

An economy has equal increases in government purchases and lump-sum taxes of ₹200 crore each, keeping the budget balanced. If MPC is 0.6, what is the resulting change in equilibrium income?

Income rises by ₹200 crore. Under the balanced budget multiplier, an equal rise in government spending and lump-sum taxes raises income by exactly the amount of the spending change, since the multiplier equals one. Here the spending effect of ₹500 crore is offset by a tax effect of ₹300 crore.

  1. A₹500 crore
  2. B₹200 croreCorrect
  3. C₹300 crore
  4. DZero

Explanation

Spending effect = 200 x 1/(1 - 0.6) = 200 x 2.5 = ₹500 crore. Tax effect = -200 x 0.6/0.4 = -₹300 crore. Net change = ₹200 crore, which equals the balanced budget multiplier of 1 times 200. Zero is wrong because the multiplier is one, not zero.

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