Analyzing Statement 1: Government Spending vs. Transfer Payments

Statement 1 compares the impact of direct government spending with transfer payments on national income. Let's consider an additional amount of money, denoted as '\( \X \)'.

• Direct Government Spending: When the government spends '\( \X \)' (e.g., on infrastructure projects, public services), this amount is directly injected into the economy as demand for goods and services.
• Transfer Payments: When the government gives '\( \X \)' as a transfer (e.g., subsidies, welfare payments) to households, households receive this money. However, they will typically spend only a fraction of it, based on their Marginal Propensity to Consume (MPC), and save the rest. The initial spending generated from the transfer is '\( \X \times \text{MPC} \)'.

Since the MPC is always less than 1, the initial increase in aggregate demand from a transfer payment of '\( \X \)' is less than the initial increase in aggregate demand from direct government spending of '\( \X \)'. Therefore, direct government spending is generally considered to have a larger, not lesser, impact on income than an equivalent amount in transfer payments.

Conclusion for Statement 1: The statement claims government spending has *less* impact, which contradicts standard economic principles. Thus, Statement 1 is incorrect.

Analyzing Statement 2: Government Spending and Money Supply

Statement 2 relates the impact of government spending on income to the expansion of the money supply.

• Government spending is a form of fiscal policy. Its effectiveness in boosting income (aggregate demand) can be influenced by monetary policy.
• Scenario: Spending without Money Supply Expansion: If government spending increases without a corresponding increase in the money supply, it might lead to higher demand for money. This could potentially increase interest rates. Higher interest rates can discourage private investment (a phenomenon called "crowding out"), thereby reducing the overall positive impact on national income. The impact relies heavily on the fiscal multiplier, influenced by factors like taxes and savings.
• Scenario: Spending with Money Supply Expansion: If the government spending is accompanied by an expansion of the money supply (e.g., the central bank buys government bonds), it can help keep interest rates lower or even decrease them. This accommodates the fiscal expansion, potentially mitigating the crowding-out effect and allowing for a larger increase in aggregate demand and national income.

The statement argues that the impact on income is *less* if spending is *not* accompanied by money supply expansion. This aligns with the understanding that accommodating monetary policy generally enhances the effectiveness of fiscal policy.

Conclusion for Statement 2: The impact of government spending is generally considered to be less pronounced when it is not supported by an expansion in the money supply, due to potential interest rate hikes and crowding out effects. Thus, Statement 2 is correct.

Final Conclusion

Based on the analysis of both statements:

• Statement 1 is incorrect.
• Statement 2 is correct.

Therefore, only Statement 2 is correct.