Question

Following is the consumption function in an economy:
C = 75 + 0.6Y

If the investment level in an economy is Rs. 400 crores, what will be:

(a) Equilibrium level of income

(b) APC at equilibrium level

(c) Value of multiplier

OR

(a) What is fiscal policy?

(b) Explain various fiscal policy measures to reduce deficient demand.

Answer 1

(a) At equilibrium level of income,
$AD=ASC+I=Y75+0.6Y+400=YY=Rs.1187.5$

(b) APC at equilibrium level,
$APC=C/YC=75+0.6Y=75+0.6\left(1187.5\right)=Rs.787.5APC=\frac{787.5}{1187.5}=Rs.0.66$

(c) Value of multiplier =$\frac{1}{1-MPC}=\frac{1}{1-06}=\frac{1}{0.4}=25$

OR

(a) Fiscal Policy:
It is the policy relating to the Government's revenue and expenditure expressed in the budget.

(b) In order to increase aggregate expenditure, the Government can adopt the following measures:

(i) Decrease taxes: Direct and indirect taxes should be reduced. This will increase the disposable income in the hands of people, who have more to spend on consumption.

(ii) Increase public expenditure: In case of deficient demand, the Government should increase the public expenditure, on projects like construction of roads, bridges, buildings, etc. in this way, more money will flow into the hands of people and thereby they will spend more.

(iii) Deficit financing: The printing of new currency notes should be encouraged so that more money flows into the economy and demand level rises.

(iv) Public borrowing: Public borrowing should be discouraged by the Government in the situation of deficient demand. Although it may lead to a budget deficit, it may fill up the deflationary gap.