The government directly affects the level of equilibrium income in two specific ways. Which of the following describes them?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Its purchases of goods and services increase aggregate demand, and taxes and transfers affect the relation between income and disposable income
Government purchases (G) are part of total spending, so they raise aggregate demand directly. Taxes and transfers change disposable income, the part of income households can spend or save.
Money supply and interest rates belong to monetary policy. The exchange rate and exports belong to the open economy.
NCERT (2026-27): “Box 5.1: Fiscal Policy … In what follows, we study the effects of introducing the government sector in our earlier analysis of the determination of income. The government directly affects the level of equilibrium income in two specific ways – government purchases of goods and services (G) increase aggregate demand and taxes, and transfers affect the relation between income (Y) and disposable income (YD) – the income available for consumption and saving with the households.” |