Answer to Question #206180 in Macroeconomics for Aaru

Question

Government decides to increase the expenditure on giving subsidies to the farmers by Rs. 10 crore. As per a team of experts instead of giving subsidies, government should

increase spending of Rs.10 crore on building the cold storages and roads. Use the

concept of multiplier to explain you are in favour of which type of spending: on

subsides or cold storages and roads? Let’s assume MPC is 0.8 and t=.25 and Y0= Rs.

600 crore. Use diagrams to explain your answer.

Answer 1

The concept of the multiplier explains that the output in the economy is a multiple of the increase or decrease in spending. In the case where the fiscal multiplier is greater than 1, a $1 increase in spending increases the total output by a value greater than $1.

The increase from AD1 to AD2 leads to an increase in output from Y1 to Y2. But with a multiplier, there is a rise to AD and a further increase in output at Y3.

A subsidy is a relief offerd to an individual, business, or institution, usually by the government to remove some type of burden, and it is often considered to be in the overall interest of the public, given to promote a social good or an economic policy.

In this case, the experts are right because increased expenditure would encourage consumption and investment thereby contributing to the increase in GDP.