CA Foundation · Business Economics · Business Cycles
An economy is in recession. The government raises spending by ₹100 crore and finances it by a lump-sum tax of ₹100 crore. With MPC = 0.6, what is the net change in income according to the balanced budget multiplier?
Income rises by ₹100 crore. The spending multiplier of 2.5 adds ₹250 crore, while the lump-sum tax multiplier of minus 1.5 removes ₹150 crore, leaving ₹100 crore. This confirms that the balanced budget multiplier equals one, so income rises by the amount of the budget increase.
- AZero
- B₹100 croreCorrect
- C₹150 crore
- D₹250 crore
Explanation
Government spending multiplier = 1/(1-0.6) = 2.5, so the spending effect is +250. Tax multiplier = -0.6/0.4 = -1.5, so the tax effect is -150. The net change is 250 - 150 = ₹100 crore, which equals the size of the budget increase (balanced budget multiplier = 1). Saying zero wrongly assumes spending and taxes cancel out.
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