In an open economy, arrange the following steps of the multiplier process in the correct order:
(A) The induced rise in demand for domestic goods, and so in domestic income, is smaller than in a closed economy.
(B) Government spending rises.
(C) Consumption rises, and a part of this rise is a demand for foreign goods.
(D) Income rises directly by the rise in spending.
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → (B), (D), (C), (A)
Each step follows from the one before it.
(B) Government spending rises — the autonomous change that starts the process.
(D) Income rises directly by the rise in spending — the direct effect on income.
(C) Consumption rises, and a part of this rise is a demand for foreign goods — the induced effect; with an MPC above zero, part of it goes on imports.
(A) The induced rise in demand for domestic goods, and so in domestic income, is smaller than in a closed economy — because part of the spending leaks abroad.
NCERT (2026-27): “… A change in autonomous expenditures, for instance a change in government spending, will have a direct effect on income and an induced effect on consumption with a further effect on income. With an mpc greater than zero, a proportion of the induced effect on consumption will be a demand for foreign, not domestic goods. Therefore, the induced effect on demand for domestic goods, and hence on domestic income, will be smaller. The increase in imports per unit of income constitutes an additional leakage from the circular flow of domestic income at each round of the multiplier process and reduces the value of the autonomous expenditure multiplier.” |