With lump-sum taxes and marginal propensity to consume c, the change in equilibrium income for each unit change in government transfers is:
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → c/(1 − c)
A rise in transfers reaches spending only through disposable income. People spend a fraction c of it and save the rest, so the first round of spending is cΔTR.
That gives the transfer multiplier \( \displaystyle \frac{\Delta Y}{\Delta TR} = \frac{c}{1-c} \).
It is smaller than the government expenditure multiplier 1/(1 − c), since a part of the transfer is saved. The tax multiplier, −c/(1 − c), has the same size with a minus sign, because a tax rise cuts income. The balanced budget multiplier is 1.
NCERT (2026-27): “Box 5.1: Fiscal Policy … Transfers: We suppose that instead of raising government spending in goods and services, government increases transfer payments, TR …” “… 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. …” “… Thus, we find that income increases by less than it increased with a rise in government purchases.” |