Answer to Question #208100 in Macroeconomics for Sona

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 subsidies or cold storage and roads? Let's assume MPC is 0.8 and t=.25 and y= 600 crore. Use diagram to explain your answer.

Answer 1

The multiplier concept explains that production in the economy is the result of spending. When the fiscal multiplier is greater than 1, an increase of one dollar will increase production by more than one.

The form of increase from AD1 towards AD2 contributes to an increase in the output of Y1 towards Y2. However, as the multiplier increases, the AD as well as production in the third year further increase. 

 Subsidies tend to refer to the relief availed by the government to individuals and businesses to minimize certain burdens or increase the production of goods and services. 

 In this case, the savvies are right, since higher spending stimulates investment and consumption, thereby boosting GDP growth.