In the two-sector model of income determination, when does aggregate demand rise?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → When people plan to spend more on consumption at every level of income
AD is planned consumption plus planned investment. If people plan to spend more on consumption at every income, AD rises.
Option (1) When people plan to spend more on consumption at every level of income — Correct. Higher planned consumption at each income raises AD.
Option (2) When autonomous investment falls — Incorrect. Less investment lowers AD.
Option (3) When the MPC falls — Incorrect. A lower MPC means less consumption out of each income, so AD falls.
Option (4) When firms plan to add less to their inventories — Incorrect. Planned additions to inventories are part of planned investment, so planning to add less lowers AD.
NCERT (2026-27): “4.3.2 Effect of an Autonomous Change in Aggregate Demand on Income and Output … Thus, if aggregate demand changes, the equilibrium level of income changes. This can happen in any one or combination of the following situations: 1. Change in consumption: this can happen due to (i) change in C̄ (ii) change in c .” “4.2 Determination of Income in Two-sector Model … The inventory investment can take place due to two reasons: (i) the firm decides to keep some stocks for various reasons (this is called planned inventory investment)” |