Consider the following statements about the effects of the government on equilibrium income:
(A) With proportional taxes, the slope of the aggregate demand line falls from c to c(1 − t).
(B) A lump-sum tax makes the aggregate demand line flatter.
(C) The transfer multiplier is equal in absolute value to the tax multiplier.
(D) A rise in government purchases of 100, financed by an equal rise in lump-sum taxes, leaves income unchanged.
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → (A) and (C) only
Each statement is about how a tax, a transfer or a budget change acts on the AD line and the multiplier.
(A) With proportional taxes, the slope of the aggregate demand line falls from c to c(1 − t). — Correct. A proportional tax takes a part of every extra rupee of income, so the mpc out of income falls to c(1 − t).
(B) A lump-sum tax makes the aggregate demand line flatter. — Incorrect. A lump-sum tax does not depend on income. It shifts the line down in parallel; the slope stays c.
(C) The transfer multiplier is equal in absolute value to the tax multiplier. — Correct. The transfer multiplier is c ÷ (1 − c) and the tax multiplier is −c ÷ (1 − c). Only the sign differs.
(D) A rise in government purchases of 100, financed by an equal rise in lump-sum taxes, leaves income unchanged. — Incorrect. The balanced budget multiplier is 1, so income rises by 100.
NCERT (2026-27): “Box 5.1: Fiscal Policy … We note that proportional taxes not only lower consumption at each level of income but also lower the slope of the consumption function. The mpc out of income falls to c (1 – t). …” “Graphically, we find that the lump-sum tax shifts the consumption schedule downward in a parallel way and hence the aggregate demand curve shifts in a similar fashion. …” “A balanced budget multiplier of unity implies that a 100 increase in G financed by 100 increase in taxes increases income by just 100. …” |