The government decides to increase its expenditure by Rs 200 billion. If the marginal propensity to consume (MPC) in the economy is 0.6, by how much will the equilibrium national income rise?

medium 2 marks Class 12 · Economics · Determination of Income and Employment

Answer

Rs 500 billion

The correct answer is Rs 500 billion — Compute: $Δ Y = 500$ billion rupees.

Step-by-step solution

Calculate the multiplier using $k = \frac{1}{1 - MPC}$ .
With MPC = 0.6, $k = \frac{1}{1 - 0.6} = \frac{1}{0.4} = 2.5$ .
The change in equilibrium income ( $Δ Y$ ) is the multiplier times the change in government spending ( $Δ G$ ).
Substitute values: $Δ Y = 2.5 \times 200$ billion rupees.
Compute: $Δ Y = 500$ billion rupees.

Common mistake: Using the multiplier without accounting for the correct sign or forgetting to multiply the change in spending.

Concept tested: Fiscal policy multiplier