CA Foundation · Business Economics · Determination of National Income
In a three-sector economy with lump-sum taxes, the marginal propensity to consume out of disposable income is 0.8. If the government increases its purchases by ₹100 crore with no change in taxes, by how much does equilibrium national income change?
Equilibrium income rises by ₹500 crore. With lump-sum taxes the government spending multiplier equals 1 divided by (1 minus MPC), which is 1/0.2 = 5. Multiplying the ₹100 crore increase in government purchases by 5 gives the rise in national income.
- A₹400 crore
- B₹500 croreCorrect
- C₹100 crore
- D₹800 crore
Explanation
With lump-sum taxes the government expenditure multiplier is 1/(1 - MPC) = 1/(1 - 0.8) = 5. Change in income = 5 x 100 = ₹500 crore. The figure ₹400 crore wrongly uses the tax multiplier magnitude MPC/(1 - MPC) = 4.
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