Understanding the Economic Concepts

This question relates to the concept of the Marginal Propensity to Consume (MPC) and its effect on national income through the tax multiplier. The MPC represents the proportion of an increase in disposable income that is spent on consumption.

When the government increases tax revenues, it reduces the disposable income available to individuals. This reduction in disposable income leads to a decrease in consumption spending, which has a multiplied effect on the overall national income.

Calculating the Impact on National Income

The change in national income resulting from a change in taxes can be determined using the tax multiplier. The formula for the tax multiplier is:

$ \text{Tax Multiplier} = - \frac{MPC}{1 - MPC} $

Given values in the question:

• Marginal Propensity to Consume (MPC) = 0.8
• Initial increase in tax revenues = Rs. 100

Step-by-Step Calculation:

1. Calculate the Tax Multiplier: Substitute the MPC value into the formula: $ \text{Tax Multiplier} = - \frac{0.8}{1 - 0.8} $ $ \text{Tax Multiplier} = - \frac{0.8}{0.2} $ $ \text{Tax Multiplier} = -4 $
2. Calculate the Change in National Income: The change in national income ($ \Delta Y $) is calculated by multiplying the tax multiplier by the initial change in tax revenue ($ \Delta T $). $ \Delta Y = \text{Tax Multiplier} \times \Delta T $ $ \Delta Y = -4 \times \text{Rs. } 100 $ $ \Delta Y = \text{Rs. } -400 $

Conclusion

The calculation shows that an initial increase in tax revenues by Rs. 100, with an MPC of 0.8, will lead to a decrease in national income by Rs. 400. This is because the decrease in disposable income reduces consumption, and this reduction has a multiplied effect throughout the economy.