Consider the following statements: 1. An additional spending by the Government of ₹ X is likely to have less impact on income than an additional transfer of ₹ X to households. 2. An additional spending by the Government of ₹ X is likely to have less impact on income if it is not accompanied by an expansion in money supply. Which of the statements given above is/are correct?
- (a)1 only
- (b)2 only
- (c)Both 1 and 2
- (d)Neither 1 nor 2
Correct — B, 2 only. Statement 1 has the ranking the wrong way round. A rupee the government spends is itself a rupee of demand, and only then does it get re-spent by whoever receives it; a rupee transferred to households first has to survive their decision to save part of it. In the simple Keynesian model the government-spending multiplier is 1/(1−c) while the transfer multiplier is c/(1−c), where c is the marginal propensity to consume. Since c is less than one, spending beats transfers, not the other way round. Statement 2 is the standard monetary-accommodation result. A fiscal expansion raises income, which raises the demand for money; with the money supply held fixed the interest rate must rise, and the higher rate squeezes out interest-sensitive private investment. That crowding out cuts the net gain in income, so the same spending does less work when the money supply is not allowed to expand alongside it.
- (a)1 only — Keeps the inverted statement and drops the sound one. Direct government purchases add to demand in full; transfers add only the part households choose to spend.
- (c)Both 1 and 2 — Statement 2 is right, but statement 1 reverses the standard multiplier ranking, so 'both' fails.
- (d)Neither 1 nor 2 — Rejects the crowding-out point, which is exactly what the IS–LM framework predicts when a fiscal expansion is not accommodated by money growth.
The expenditure multiplier measures how much equilibrium income rises per rupee of autonomous demand. Government purchases enter demand directly, giving a multiplier of 1/(1−c). A transfer payment enters only through household consumption, so its first-round effect is c rupees and its multiplier is c/(1−c) — smaller by exactly one unit of the spending multiplier. Whether the full multiplier is realised then depends on the monetary side: in IS–LM, a rightward shift of the IS curve along an upward-sloping LM curve raises both income and the interest rate, and the interest-rate rise partly offsets the expansion.
The item is really two textbook results wearing current-affairs clothes. For statement 1 the quickest check is the first round: ₹X of government purchase is ₹X of demand immediately, whereas ₹X handed to households becomes only ₹cX of demand. For statement 2, ask what happens to the money market when income rises and the central bank does nothing — money demand rises against a fixed supply, rates go up, private investment falls, and the multiplier is damped. Both are pure reasoning items; no numbers are needed.
- Government-spending multiplier = 1/(1−c); transfer (or tax) multiplier = c/(1−c), where c is the marginal propensity to consume.
- The two differ by exactly 1, which is why a rupee of purchases always beats a rupee of transfers in the simple model.
- In IS–LM, an unaccommodated fiscal expansion raises the interest rate and crowds out private investment, reducing the realised multiplier.
- A flatter LM curve — money supply expanding with income — leaves more of the multiplier intact; a vertical LM curve leaves none of it.
- Assuming transfers are more powerful because the money 'reaches people directly' — the first round is smaller, not larger.
- Forgetting that the balanced-budget multiplier equals one, which is a third distinct case.
- Reading 'expansion in money supply' as inflation rather than as the accommodation that prevents the interest rate from rising.
As a two-statement item comparing spending with transfers, or as a direct question on which multiplier is larger and why.
No directly related past PYQ was found.
- practice — not a real PYQ
In the simple Keynesian model, if the marginal propensity to consume is 0.8, the government-spending multiplier is
- (a)0.8
- (b)4
- (c)5
- (d)8
Answer(c) 5 — the multiplier is 1/(1−c) = 1/(1−0.8) = 5; the transfer multiplier would be c/(1−c) = 4.
- practice — not a real PYQ
A fiscal expansion that is not accompanied by any increase in the money supply will typically
- (a)raise the interest rate and crowd out private investment
- (b)lower the interest rate and crowd in private investment
- (c)leave the interest rate unchanged
- (d)reduce national income below its initial level
Answer(a) raise the interest rate and crowd out private investment — higher income raises money demand against a fixed supply, pushing rates up.