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CA Foundation · Business Economics · Determination of National Income

In the Keynesian framework, the government expenditure multiplier in an economy with lump-sum taxes is larger than the tax multiplier (in absolute value) because:

The spending multiplier is larger because government expenditure adds to aggregate demand by the full amount in the first round. A tax change alters disposable income, and only the fraction MPC is spent initially while the rest is saved, so its effect is smaller.

  1. AGovernment spending directly adds to aggregate demand in full, while a tax change affects it only through the induced change in consumptionCorrect
  2. BTaxes are always collected after spending takes place
  3. CGovernment spending is financed by printing money, which has no leakage
  4. DThe marginal propensity to save is zero for the government sector

Explanation

A rupee of government spending enters aggregate expenditure fully in the first round. A rupee of tax cut raises disposable income, but only MPC of it is spent initially, the rest being saved. Hence the tax multiplier is smaller by exactly 1 than the spending multiplier in magnitude.

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