Autonomous investment rises and the aggregate demand line shifts in parallel from AD1 to AD2. E1 and E2 are the points where AD1 and AD2 cut the 45° line, and F is the point on AD2 directly above E1. Which of the following pairs is correctly matched?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → E1F – the excess demand that emerges at the old equilibrium output
After investment rises, AD2 lies above AD1. At the old output, demand is now higher than output by E1F. This gap is the excess demand.
Option (1) E1F – the total increase in equilibrium output — Incorrect. E1F is equal to the rise in investment, ΔI. The total rise in output is E1G, which is larger.
Option (2) E2 – the old equilibrium point that is no longer an equilibrium — Incorrect. E2 is the new equilibrium point. E1 is the old one.
Option (3) AD2 – the aggregate demand line before the rise in investment — Incorrect. AD2 is the line after the rise in investment.
Option (4) E1F – the excess demand that emerges at the old equilibrium output — Correct. At output Y1*, AD2 is higher than output by E1F.
NCERT (2026-27): “4.3.2 Effect of an Autonomous Change in Aggregate Demand on Income and Output … E1F measures the amount of excess demand that emerges in the economy as a result of the increase in autonomous expenditure. Thus, E1 no longer represents the equilibrium. To find the new equilibrium in the final goods market we must look for the point where the new aggregate demand line, AD2, intersects the 45° line. That occurs at point E2, which is, therefore, the new equilibrium point. The new equilibrium values of output and aggregate demand are Y*2 and AD*2, respectively. Note that in the new equilibrium, output and aggregate demand have increased by an amount E1G = E2G, which is greater than the initial increment in autonomous expenditure, ΔI = E1F = E2 J.” |