In a two-sector economy, people become more thrifty and the mpc falls, with autonomous consumption unchanged. At the same time, firms raise their autonomous investment. How does the new aggregate demand line compare with the old one?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → It starts from a higher point on the vertical axis and is flatter
The AD line starts at C̄ + Ī on the vertical axis and has slope c. Two things change here at once.
- Autonomous investment rises, so the intercept rises: the line starts higher.
- The mpc falls, so the slope falls: the line becomes flatter.
Option (1) It starts from a higher point on the vertical axis and is flatter — Correct. Both changes are shown.
Option (2) It starts from a higher point on the vertical axis and is steeper — Incorrect. A lower mpc makes the line flatter, not steeper.
Option (3) It starts from the same point on the vertical axis and is flatter — Incorrect. The intercept cannot stay the same, because autonomous investment has risen.
Option (4) It is parallel to the old line and lies above it — Incorrect. A parallel line needs the same slope. The slope has changed because the mpc has fallen.
NCERT (2026-27): “Aggregate Demand: Graphical Representation The Aggregate Demand function shows the total demand (made up of consumption + investment) at each level of income. Graphically it means the aggregate demand function can be obtained by vertically adding the consumption and investment function. … The aggregate demand function is parallel to the consumption function i.e., they have the same slope c. It may be noted that this function shows ex ante demand.” “Paradox of Thrift … When A changes the line shifts upwards or downwards in parallel. When c changes, however, the line swings up or down. An increase in mps, or a decline in mpc, reduces the slope of the AD line and it swings downwards. We depict the situation in Fig. 4.8.” |