The marginal propensity to consume is 0.8. Arrange the following in decreasing order of value:
(A) Government expenditure multiplier with lump-sum taxes
(B) Absolute value of the tax multiplier
(C) Balanced budget multiplier
(D) Government expenditure multiplier with a proportional tax rate of 0.25
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → (A), (B), (D), (C)
Work out each value at c = 0.8.
(A) 1 ÷ (1 − 0.8) = 1 ÷ 0.2 = 5
(B) 0.8 ÷ 0.2 = 4
(D) 1 ÷ (1 − 0.8 × 0.75) = 1 ÷ 0.4 = 2.5
(C) The balanced budget multiplier is always 1.
A proportional tax lowers the multiplier because consumption now rises by only c(1 − t) of each extra unit of income.
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. …” “… With proportional taxes, consumption will rise by less, (c – ct = c (1 – t)) times the increase in income. …” “In Example 5.1, if we take a tax rate of 0.25, we find consumption will now rise by 0.60 (c (1 – t) = 0.8 × 0.75) for every unit increase in income instead of the earlier 0.80. Thus, consumption will increase by less than before. …” |