Answer to Question #206256 in Macroeconomics for Aku

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 multiplier explains that output in the economy is a result of spending. When the fiscal multiplier is greater than one, an increase in $1 will increase the output by 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 refers to the relief offered by the government to individuals and businesses to remove some burden or increase the production of goods and services.

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