Assertion (A): When investment falls, the government can keep equilibrium income unchanged by raising its spending by the same amount.
Reason (R): A proportional income tax makes disposable income less sensitive to fluctuations in GDP.
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → Both (A) and (R) are true but (R) is not the correct explanation of (A).
Assertion (A): When investment falls, the government can keep equilibrium income unchanged by raising its spending by the same amount. — True. If G rises as much as I falls, autonomous expenditure stays the same, so income stays the same.
Reason (R): A proportional income tax makes disposable income less sensitive to fluctuations in GDP. — True. Part of any rise in GDP goes as tax, so disposable income moves less. This is an automatic stabiliser.
Why R does not explain A?
A is a deliberate action, called discretionary fiscal policy. R is about a tax that works on its own, with no decision. The real explanation of A is that equilibrium income depends on autonomous expenditure; raising G to make up for the fall in I keeps that total unchanged.
NCERT (2026-27): “Box 5.1: Fiscal Policy … The proportional income tax, thus, acts as an automatic stabiliser – a shock absorber because it makes disposable income, and thus consumer spending, less sensitive to fluctuations in GDP. When GDP rises, disposable income also rises but by less than the rise in GDP because a part of it is siphoned off as taxes. This helps limit the upward fluctuation in consumption spending. During a recession when GDP falls, disposable income falls less sharply, and consumption does not drop as much as it otherwise would have fallen had the tax liability been fixed. This reduces the fall in aggregate demand and stabilises the economy. We note that these fiscal policy instruments can be varied to offset the effects of undesirable shifts in investment demand. That is, if investment falls from I0 to I1, government spending can be raised from G0 to G1 so that autonomous expenditure (C + I0 + G0 = C + I1 + G1) and equilibrium income remain the same. This deliberate action to stabilise the economy is often referred to as discretionary fiscal policy to distinguish it from the inherent automatic stabilising properties of the fiscal system. …” |