Assertion (A): An increase in government spending raises equilibrium income by more than an equal cut in lump-sum taxes.
Reason (R): Government spending directly affects total spending, whereas taxes enter the multiplier process through their impact on disposable income.
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Both (A) and (R) are true and (R) is the correct explanation of (A).
Assertion (A): An increase in government spending raises equilibrium income by more than an equal cut in lump-sum taxes. — True. The tax multiplier is smaller in absolute value. With c = 0.8, a rise of 100 in G raises income by 500; a tax cut of 100 raises it by 400.
Reason (R): Government spending directly affects total spending, whereas taxes enter the multiplier process through their impact on disposable income. — True. G is itself a part of total spending. A tax cut first changes disposable income.
Why R explains A?
A rise in G adds the full amount to spending in the first round. A tax cut of the same size raises consumption by only c times the cut, because part of the extra income is saved. So the first push, and the whole chain, is smaller for a tax cut.
NCERT (2026-27): “Box 5.1: Fiscal Policy … Because a tax cut (increase) will cause an increase (reduction) in consumption and output, the tax multiplier is a negative multiplier. Comparing equation (5.6) and (5.8), we find that the tax multiplier is smaller in absolute value compared to the government spending multiplier. This is because an increase in government spending directly affects total spending whereas taxes enter the multiplier process through their impact on disposable income, which influences household consumption (which is a part of total spending). Thus, with a ΔT reduction in taxes, consumption, and hence total spending, increases in the first instance by cΔT. …” |