(a)OR(b)

“An economy is operating at under-employment level of income.”

What does this situation indicate ? Discuss any one fiscal measure to tackle this situation.

The aforesaid situation indicates the problem of Deficient Demand.To tackle the situation of Deficient Demand in the economy, the government may decrease the tax rate which may increase the disposable income (purchasing power) in the hands of the general public. Consequently, it may lead to a rise in Aggregate Demand (AD), thereby correcting the situation of deficient demand.The working of the multiplier is based on the fact that one's expenditure is another's income. Suppose the increase in investment is (ΔI) by ₹ $\displaystyle 1,000$ crore and the Marginal Propensity to Consume (MPC) is $\displaystyle 0.8$:

Round	Increase in investment (ΔI) (in crore)	Increase in income (ΔY) (in crore)	Increase in consumption (ΔC) (in crore)	Increase in savings (ΔS) (in crore)
$\displaystyle 1$	$\displaystyle 1,000$	$\displaystyle 1,000$	$\displaystyle 800$	$\displaystyle 200$
$\displaystyle 2$	—	$\displaystyle 800$	$\displaystyle 640$	$\displaystyle 160$
$\displaystyle 3$	—	$\displaystyle 640$	$\displaystyle 512$	$\displaystyle 128$
—	—	.	.	.
—	—	.	.	.
Total	$\displaystyle 1,000$	$\displaystyle 5,000$	$\displaystyle 4,000$	$\displaystyle 1,000$

Thus, the above table reflects an increment in investment (ΔI) of ₹ $\displaystyle 1,000$ crore, which results in multiple effect on income. Thereby, increasing income to ₹ $\displaystyle 5,000$ crore.Working Note:$\displaystyle K = \frac{1}{1 - MPC} = \frac{1}{1 - 0.8} = 5$$\displaystyle K = \frac{\Delta Y}{\Delta I}$$\displaystyle 5 = \frac{\Delta Y}{1,000}$ΔY = ₹ $\displaystyle 5,000$ crore