Question

In the context of the Keynesian concept of a multiplier, a 1 increase in government spending financed by a 1 increase in taxes will cause equilibrium income

• A. unchanged
• B. increased by $1
• C. to change depending on the value of the marginal propensity to consume
• D. decrease by $1

Hint:

The effect of an increase in government spending financed by higher taxes depends on the marginal propensity to consume. A higher MPC results in a larger multiplier effect and a greater change in equilibrium income.

Answer 1

The Correct Option is C

In Keynesian economics, the multiplier effect refers to the process by which an initial change in government spending leads to a larger change in equilibrium income. When the government increases its spending, it increases demand for goods and services, which leads to an increase in income and output. However, financing the spending with a tax increase reduces disposable income and thus reduces consumption, leading to a smaller increase in equilibrium income. The change in equilibrium income depends on the marginal propensity to consume (MPC). The MPC is the fraction of additional income that is spent on consumption. If the MPC is high, the multiplier effect is stronger, leading to a larger increase in equilibrium income. 

- (A) Unchanged: This is incorrect. The equilibrium income will change because the increase in taxes will reduce consumption, which affects the overall equilibrium income.
- (B) Increased by 1: This is incorrect. The increase in government spending will be offset by the decrease in consumption due to higher taxes, so the increase in equilibrium income is less than 1.
- (C) To change depending on the value of the marginal propensity to consume: This is correct. The effect on equilibrium income depends on the MPC. A higher MPC leads to a larger increase in equilibrium income.
- (D) Decrease by 1: This is incorrect. The decrease in income is not necessarily 1; it depends on the value of the MPC and the multiplier effect. The correct answer is (C), as the effect on equilibrium income depends on the value of the marginal propensity to consume. 

Final Answer: (C) To change depending on the value of the marginal propensity to consume.