In an open economy, the marginal propensity to consume is 0.8 and the marginal propensity to import is 0.2. Autonomous imports rise by Rs 30 crore, with exports and everything else unchanged. Which of the following is correct?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → Income falls by Rs 75 crore and net exports fall by Rs 15 crore.
Given:
c = 0.8
m = 0.2
Rise in autonomous imports = Rs 30 crore
A rise in autonomous imports lowers demand for domestic goods. Its effect on income works through the open economy multiplier, with a minus sign.
\( \displaystyle \text{Multiplier} = \frac{1}{1 - c + m} = \frac{1}{1 - 0.8 + 0.2} = \frac{1}{0.4} = 2.5 \)
\( \Delta Y = -2.5 \times 30 = -75 \)
Income falls by Rs 75 crore.
Imports have two parts, M = autonomous imports + mY. The fall in income cuts the induced part.
\( \Delta M = 30 + 0.2 \times (-75) = 30 - 15 = 15 \)
Exports do not change, so net exports (X − M) fall by Rs 15 crore, not by the full Rs 30 crore.
NCERT (2026-27):
“DETERMINATION OF EQUILIBRIUM INCOME IN OPEN ECONOMY … An increase in demand for our exports is an increase in aggregate demand for domestically produced output and will increase demand just as would an increase in government spending or an autonomous increase in investment. In contrast, an autonomous rise in import demand is seen to cause a fall in demand for domestic output and causes equilibrium income to decline.” |
