In the income determination model with a government, which of the following pairs is correctly matched?
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → Disposable income of households – Y – T
Taxes take a part of income away from households. What is left is disposable income, Yd = Y − T.
Option (1) Taxes (T) – add to aggregate demand like the spending of firms and households — Incorrect. Taxes take income away from households. It is government expenditure that adds to aggregate demand.
Option (2) Disposable income of households – Y – T — Correct. Households spend a fraction of this disposable income on consumption.
Option (3) Government expenditure (G) – takes a part of income away from households — Incorrect. G adds to aggregate demand, like the spending of firms and households. Taking income away is what taxes do.
Option (4) G – cT – is subtracted from the autonomous term A — Incorrect. G − cT adds to the autonomous term A, like C̄ or Ī.
NCERT (2026-27): “4.2 Determination of Income in Two-sector Model … At this point, we can introduce a government in this economy. The major economic activities of the government that affect the aggregate demand for final goods and services can be summarized by the fiscal variables Tax (T) and Government Expenditure (G), both autonomous to our analysis. Government, through its expenditure G on final goods and services, adds to the aggregate demand like other firms and households. On the other hand, taxes imposed by the government take a part of the income away from the household, whose disposable income, therefore, becomes Yd = Y – T. Households spend only a fraction of this disposable income for consumption purpose. Hence, equation (4.3) has to be modified in the following way to incorporate the government Y = C̄ + Ī + G + c (Y – T ) Note that G – c.T , like C̄ or Ī , just adds to the autonomous term A .” |