The marginal propensity to consume is 0.8 and taxes are lump-sum. Three of the following values are correct. Which one is the odd one out?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → Transfer multiplier = 5
With MPC (c) = 0.8 and lump-sum taxes, three multipliers can be worked out from c.
Government expenditure multiplier = 1 ÷ (1 − c) = 1 ÷ 0.2 = 5
Tax multiplier = −c ÷ (1 − c) = −0.8 ÷ 0.2 = −4
Balanced budget multiplier = 5 + (−4) = 1
Transfer multiplier = c ÷ (1 − c) = 0.8 ÷ 0.2 = 4
So the value 5 for transfers is wrong. A transfer enters spending only through consumption, and a part of it is saved, so it raises income less than an equal rise in G.
NCERT (2026-27): “Box 5.1: Fiscal Policy … 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.” “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. …” |