Consider an economy where the consumption function is $C=100+0.7(Y-T)$, investment is $I=80$, initial government expenditure is $G=120$, and taxes are flat $30$. Net exports are zero. If the government increases its expenditure by Rs. 50 billion and simultaneously raises taxes to 10% of the new income ($T=0.1Y$), what will be the new equilibrium level of national income?

Step-by-step solution

1. Step 1: Write the initial equilibrium identity: $Y_0=C+I+G$ with $C=100+0.7(Y_0-30)$, $I=80$, $G=120$ and $T=30$.
2. Step 2: Simplify the consumption part: $C=100+0.7Y_0-21=79+0.7Y_0$.
3. Step 3: Substitute into the identity: $Y_0=79+0.7Y_0+80+120=279+0.7Y_0$.
4. Step 4: Solve for $Y_0$: $Y_0-0.7Y_0=279\Rightarrow 0.3Y_0=279\Rightarrow Y_0=930$ (initial equilibrium).
5. Step 5: Apply the fiscal changes: new $G^{\prime }=120+50=170$, new $T^{\prime }=0.1Y$ (variable).
6. Step 6: Write the new consumption function: $C^{\prime }=100+0.7(Y-0.1Y)=100+0.63Y$.
7. Step 7: Set up the new equilibrium: $Y=C^{\prime }+I+G^{\prime }=(100+0.63Y)+80+170=350+0.63Y$.
8. Step 8: Solve for $Y$: $Y-0.63Y=350\Rightarrow 0.37Y=350\Rightarrow Y=\frac{350}{0.37}\approx 946$.
9. Step 9: Conclude that the new equilibrium national income is about Rs. 946 billion.

Concept tested: Fiscal policy and multiplier

Published 7 October 2026 · How this solution was prepared and checked