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CA Foundation · Business Economics · Determination of National Income

In a three-sector economy with lump-sum taxes, MPC out of disposable income is 0.75. If the government raises lump-sum taxes by ₹80 crore, with government spending unchanged, what is the change in equilibrium income?

Equilibrium income falls by ₹240 crore. The lump-sum tax multiplier is negative MPC divided by (1 minus MPC), which is -0.75/0.25 = -3. Multiplying the ₹80 crore tax increase by -3 gives the fall in income. Taxes first reduce disposable income, and only the MPC share affects spending.

  1. ADecrease of ₹320 crore
  2. BDecrease of ₹240 croreCorrect
  3. CDecrease of ₹80 crore
  4. DIncrease of ₹240 crore

Explanation

The tax multiplier is -MPC/(1 - MPC) = -0.75/0.25 = -3. Change in income = -3 x 80 = -₹240 crore. The option of ₹320 crore wrongly applies the spending multiplier of 4, ignoring that part of the tax cut reduces saving rather than consumption.

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