Read the following statements:
Statement I: With a marginal propensity to consume of 0.75 and lump-sum taxes, an increase in transfers of 20 raises equilibrium income by 60.
Statement II: The transfer multiplier is larger than the government expenditure multiplier because transfers reach households directly.
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → Statement I is true but Statement II is false.
Statement I: With a marginal propensity to consume of 0.75 and lump-sum taxes, an increase in transfers of 20 raises equilibrium income by 60. — True. Transfer multiplier = c ÷ (1 − c) = 0.75 ÷ 0.25 = 3. So ΔY = 3 × 20 = 60.
Statement II: The transfer multiplier is larger than the government expenditure multiplier because transfers reach households directly. — False. It is smaller. Households save part of a transfer, so only c times it is spent in the first round. The same 20 spent as G raises income by 4 × 20 = 80.
NCERT (2026-27): “Box 5.1: Fiscal Policy … so output will rise by less than the amount by which it increases when government expenditure increases because a part of any increase in transfer payments is saved. …” “We suppose that the marginal propensity to consume is 0.75 and we have lump-sum taxes. …” |