The marginal propensity to consume is 0.75 and taxes are lump-sum. Three of the following changes raise equilibrium income by the same amount. Which one is the odd one out?
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → Raising both government purchases and lump-sum taxes by 20
Find each change in income with its multiplier at c = 0.75.
Expenditure multiplier = 1 ÷ (1 − 0.75) = 4
Tax multiplier and transfer multiplier = 0.75 ÷ 0.25 = 3 (the tax multiplier is negative)
Tax cut of 20: 3 × 20 = 60
Transfers up by 20: 3 × 20 = 60
Purchases up by 15: 4 × 15 = 60
Purchases and taxes both up by 20: the balanced budget multiplier is 1, so income rises by only 20.
NCERT (2026-27): “Box 5.1: Fiscal Policy … Within the present framework, if we take different values of the marginal propensity to consume and calculate the values of the two multipliers, we find that the tax multiplier is always one less in absolute value than the government expenditure multiplier. This has an interesting implication. If an increase in government spending is matched by an equal increase in taxes, so that the budget remains balanced, output will rise by the amount of the increase in government spending. …” “… 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. …” |