(a) (i) Explain the effects of public spending on national income, if it is financed through government borrowings. (ii) Why do…

Debt-financed public spending raises national income through the Keynesian multiplier: an initial increase in government expenditure raises income, consumption and further demand, so ΔY = ΔG/(1-MPC(1-t)). But if borrowing is from domestic savers, it competes for loanable funds, raises interest rates and crowds out private investment, reducing the multiplier. If the RBI accommodates by monetising debt, crowding out falls but inflation and fiscal dominance risk rise. Under Ricardian equivalence, forward-looking households expect future taxes to repay debt, save more and offset the demand effect, so income may not rise. The net effect depends on slack, expectations and debt sustainability. Productive borrowing for infrastructure can raise potential output; unproductive borrowing increases debt servicing, intergenerational burden and fiscal risk, as seen in India’s market borrowings and the Fiscal Responsibility and Budget Management Act, 2003.

Restricting public expenditure is important because unchecked growth can crowd out private activity, create inflationary pressure, raise debt, distort resource allocation, erode fiscal space and create fiscal dominance. Wagner’s Law and Peacock-Wiseman displacement effect explain why the state tends to expand, especially after crises. Control requires fiscal rules, zero-based and outcome-based budgeting, expenditure ceilings, performance audits by the CAG, user charges, public-private partnerships and disinvestment, and prioritising capital over recurrent spending.

For the competitive market, pre-tax equilibrium is found by equating demand and supply: -500P + 5000 = 400P - 400, so P = 6 and Q = 2000. Interpreting the 18% sales tax as an ad valorem tax on the consumer price, sellers receive 0.82P, so the supply function becomes Qs = 400(0.82P) - 400 = 328P - 400. Equating with demand gives 828P = 5400, so P = 6.52 and Q = 1739. The tax per unit is 0.18 × 6.52 = 1.17. Consumers pay 0.52 more and producers receive 0.65 less; consumer incidence is 0.52/1.17 = 44.4%, and producer incidence is 55.6%.

In monopoly, TR = 200q - 8q², MR = 200 - 16q, MC = 10. Pre-tax: 200 - 16q = 10, q = 11.875, p = 105. With a ₹10 per unit tax, MC becomes 20, so 200 - 16q = 20, q = 11.25, p = 110. Price rises by 5 and output falls by 0.625. The consumer bears 5 of the tax and the producer’s net price falls from 105 to 100, so pass-through is 50%. This is higher than the 44.4% consumer pass-through in the competitive example, but competitive pass-through depends on demand and supply elasticities and can be above or below 50%, so no general ranking exists.

The money multiplier is m = broad money/monetary base. In a simplified Indian banking model, m = 1/(CRR + SLR + ER); if currency drain is explicit, the denominator also includes the currency-to-deposit ratio. Determinants are CRR, SLR, excess reserves, currency drain and the public’s preference for cash. The banking system, guided by the RBI, controls money supply because credit creation is limited by reserve ratios. If the RBI raises CRR or SLR, the multiplier falls and deposit expansion slows; if it raises the repo rate, borrowing cost rises, lending falls and excess reserves may increase, also reducing the multiplier. Open market operations change the monetary base: selling government securities drains base money, while buying injects it. Since money supply equals multiplier times base, the RBI can tighten or ease liquidity by combining base changes with multiplier-affecting instruments.

Thus, debt-financed spending can raise income but must be constrained by fiscal rules; tax incidence and monopoly pricing show that market structure shapes burden; and monetary stability requires managing both the base and the multiplier.