In an economy, C = 20 + 0.75YD, where disposable income YD = Y − T + TR. Lump-sum taxes T are Rs 40 crore, transfers TR are Rs 20 crore, investment is Rs 50 crore and government purchases are Rs 60 crore. What is the equilibrium income?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → Rs 460 crore
Taxes lower disposable income and transfers raise it, so only c times each of them reaches consumption. Equilibrium income is (C̄ − cT + cTR + I + G) ÷ (1 − c).
Given:
C̄ = 20
c = 0.75
T = 40
TR = 20
I = 50
G = 60 (Rs crore)
\( \displaystyle \bar{A} = 20 - 0.75 \times 40 + 0.75 \times 20 + 50 + 60 = 115 \)
\( \displaystyle Y^{*} = \frac{115}{1 - 0.75} = \frac{115}{0.25} = 460 \)
Equilibrium income is Rs 460 crore.
Option (2) Rs 480 crore — this adds the transfers in full.
Option (3) Rs 400 crore — this leaves the transfers out.
NCERT (2026-27): “Box 5.1: Fiscal Policy … We note that taxes lower disposable income and consumption. For instance, if one earns Rs 1 lakh and has to pay Rs 10,000 in taxes, she has the same disposable income as someone who earns Rs 90,000 but pays no taxes. …” “Box 5.1: Fiscal Policy … Transfers: We suppose that instead of raising government spending in goods and services, government increases transfer payments, TR̄. Autonomous spending, Ā, will increase by cΔTR̄, 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. …” |