Which of the following statements correctly compares the effect of "Government Transfers" vs "Government Expenditure" on equilibrium income? 1. Government expenditure has a larger impact on equilibrium income than an equivalent amount of transfers. 2. Transfers affect income more than government expenditure because they are fully spent. 3. The multiplier for transfers is smaller than the government expenditure multiplier.

Correct Option The correct option is 1 and 3 only. Explanation In macroeconomics, the impact of fiscal policy on equilibrium income is measured by the multiplier effect. This concept quantifies how a change in autonomous spending (such as government expenditure or transfers) affects the overall output or income level in the economy. The magnitude of the multiplier depends on the Marginal Propensity to Consume (MPC). Statement-wise Analysis - Statement 1 is Correct: Government expenditure ($G$) is a direct component of Aggregate Demand ($AD$). When the government spends money, it directly purchases goods and services, injecting the full amount into the economy immediately. In contrast, Government Transfers ($Tr$) (e.g., unemployment benefits, subsidies) first increase households' disposable income. Households then choose to spend a portion and save a portion. Because some of the transfer leaks out as savings immediately, the initial increase in aggregate demand is smaller than the transfer amount. Therefore, $G$ has a larger impact on equilibrium income. - Statement 2 is Incorrect: Transfers are not fully spent. The consumption from transfers depends on the Marginal Propensity to Consume (MPC). Households spend only a fraction ($c$) of the transfer and save the rest ($1-c$). Since $MPC$ is typically less than 1, the initial injection into the economy is less than the total transfer amount. - Statement 3 is Correct: The formulas for the multipliers mathematically demonstrate the difference in impact: - The Government Expenditure Multiplier is $\frac{1}{1 - MPC}$. - The Transfer Multiplier is $\frac{MPC}{1 - MPC}$. Since $MPC < 1$, the numerator for the transfer multiplier ($MPC$) is smaller than the numerator for the expenditure multiplier ($1$). Consequently, the multiplier for transfers is smaller than the government expenditure multiplier. Key Takeaway Government Expenditure impacts the economy more than Transfers because expenditure is a direct injection into aggregate demand, whereas transfers are subject to "leakage" through savings before they contribute to spending.

NCERT Class 12 Economics — Chapter 7: Government Budget and the Economy

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Which of the following statements correctly compares the effect of "Government Transfers" vs "Government Expenditure" on equilibrium income?

Government expenditure has a larger impact on equilibrium income than an equivalent amount of transfers.
Transfers affect income more than government expenditure because they are fully spent.
The multiplier for transfers is smaller than the government expenditure multiplier.

Official previous-year question

Verified 1 Aug 2026.

Options

A1 and 3 only
B1, 2 and 3
C1 and 2 only
D2 only

Did you get this right?

Solution

Correct Option

The correct option is 1 and 3 only.

Explanation

In macroeconomics, the impact of fiscal policy on equilibrium income is measured by the multiplier effect. This concept quantifies how a change in autonomous spending (such as government expenditure or transfers) affects the overall output or income level in the economy. The magnitude of the multiplier depends on the Marginal Propensity to Consume (MPC).

Statement-wise Analysis

Statement 1 is Correct: Government expenditure ($G$) is a direct component of Aggregate Demand ($AD$). When the government spends money, it directly purchases goods and services, injecting the full amount into the economy immediately. In contrast, Government Transfers ($Tr$) (e.g., unemployment benefits, subsidies) first increase households' disposable income. Households then choose to spend a portion and save a portion. Because some of the transfer leaks out as savings immediately, the initial increase in aggregate demand is smaller than the transfer amount. Therefore, $G$ has a larger impact on equilibrium income.
Statement 2 is Incorrect: Transfers are not fully spent. The consumption from transfers depends on the Marginal Propensity to Consume (MPC). Households spend only a fraction ($c$) of the transfer and save the rest ($1-c$). Since $MPC$ is typically less than 1, the initial injection into the economy is less than the total transfer amount.
Statement 3 is Correct: The formulas for the multipliers mathematically demonstrate the difference in impact:
- The Government Expenditure Multiplier is $\frac{1}{1 - MPC}$.
- The Transfer Multiplier is $\frac{MPC}{1 - MPC}$.
Since $MPC < 1$, the numerator for the transfer multiplier ($MPC$) is smaller than the numerator for the expenditure multiplier ($1$). Consequently, the multiplier for transfers is smaller than the government expenditure multiplier.

Key Takeaway

Government Expenditure impacts the economy more than Transfers because expenditure is a direct injection into aggregate demand, whereas transfers are subject to "leakage" through savings before they contribute to spending.

Your note

More from Chapter 7: Government Budget and the Economy

Consider the following statements regarding the "Annual Financial Statement" in India: 1. It is a statutory requirement under the Fiscal Responsibility and Budget Management Act, not the Constitution. 2. It includes estimates for the coming financial year. 3. It distinguishes between the revenue account and the capital account. Which of the statements given above is/are correct?

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With reference to the "Allocation Function" of the government budget, consider the following statements: 1. It addresses the provision of public goods that cannot be provided effectively by the market mechanism. 2. Public goods are characterized by being rivalrous in consumption and excludable in nature. 3. The "free-rider" problem is easily solved by charging a user fee for public goods. Which of the statements given above is/are correct?

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Consider the following statements regarding "Public Provision" and "Public Production": 1. Public provision implies that goods are financed through the budget and used without direct payment. 2. Goods provided by the government must necessarily be produced directly by the government. 3. Public goods may be produced by the private sector. Which of the statements given above is/are correct?

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Consider the following statements regarding "Capital Receipts": 1. Recovery of loans is considered a revenue receipt. 2. Capital receipts either create a liability or reduce the financial assets of the government. 3. Market borrowings are considered non-debt creating capital receipts. Which of the statements given above is/are correct?

hard

Consider the following statements regarding "Revenue Expenditure": 1. It includes expenditure that does not result in the creation of assets. 2. Interest payments on debt are classified as capital expenditure. 3. Grants given to state governments are treated as revenue expenditure even if they are meant for the creation of assets. Which of the statements given above is/are correct?

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Correct Option

The correct option is 1 and 3 only.

Explanation

Statement-wise Analysis

Statement 1 is Correct: Government expenditure ($G$) is a direct component of Aggregate Demand ($AD$). When the government spends money, it directly purchases goods and services, injecting the full amount into the economy immediately. In contrast, Government Transfers ($Tr$) (e.g., unemployment benefits, subsidies) first increase households' disposable income. Households then choose to spend a portion and save a portion. Because some of the transfer leaks out as savings immediately, the initial increase in aggregate demand is smaller than the transfer amount. Therefore, $G$ has a larger impact on equilibrium income.
Statement 2 is Incorrect: Transfers are not fully spent. The consumption from transfers depends on the Marginal Propensity to Consume (MPC). Households spend only a fraction ($c$) of the transfer and save the rest ($1-c$). Since $MPC$ is typically less than 1, the initial injection into the economy is less than the total transfer amount.
Statement 3 is Correct: The formulas for the multipliers mathematically demonstrate the difference in impact:
- The Government Expenditure Multiplier is $\frac{1}{1 - MPC}$.
- The Transfer Multiplier is $\frac{MPC}{1 - MPC}$.
Since $MPC < 1$, the numerator for the transfer multiplier ($MPC$) is smaller than the numerator for the expenditure multiplier ($1$). Consequently, the multiplier for transfers is smaller than the government expenditure multiplier.