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

An economy is operating well below full capacity with low inflation. The government increases public spending by ₹2,000 crore, financed by borrowing. The marginal propensity to consume is 0.75, and there are no taxes or imports. What is the maximum total increase in national income from the multiplier effect?

National income rises by ₹8,000 crore. With a marginal propensity to consume of 0.75 and no leakages, the multiplier is 1 divided by 0.25, which is 4, and four times the ₹2,000 crore injection gives ₹8,000 crore.

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

Explanation

Multiplier = 1/(1-MPC) = 1/0.25 = 4. Increase in income = 4 x 2,000 = ₹8,000 crore. The figure of ₹6,000 crore comes from using MPC/(1-MPC) = 3, which is the multiplier for the induced consumption part only, excluding the initial injection.

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