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CA Foundation · Business Economics · Determination of National Income

In a closed economy with a government sector, the MPC is 0.75 and government expenditure is increased by ₹40 crore, financed by an equal increase in lump-sum taxes. By how much does equilibrium national income change?

Equilibrium income rises by ₹40 crore. This is the balanced budget multiplier, which equals one. Government spending adds 4 times 40, or ₹160 crore, while the equal lump-sum tax reduces income by 3 times 40, or ₹120 crore, leaving a net rise of ₹40 crore.

  1. ANo change
  2. BIncrease by ₹160 crore
  3. CIncrease by ₹40 croreCorrect
  4. DDecrease by ₹120 crore

Explanation

Government spending multiplier = 1/(1-0.75) = 4, so the effect is +160. Tax multiplier = -0.75/0.25 = -3, so the effect is -120. Net change = 160 - 120 = ₹40 crore, equal to the balanced budget multiplier of 1 times 40. Option B ignores the tax increase.

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