Assertion (A): A fall in the rate of interest can raise equilibrium income by more than the rise in investment it causes.
Reason (R): As income rises, households spend a part of the extra income, and this creates fresh excess demand round after round.
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Both (A) and (R) are true and (R) is the correct explanation of (A).
Assertion (A): A fall in the rate of interest can raise equilibrium income by more than the rise in investment it causes. — True. A lower interest rate lowers the cost of funds, so firms invest more. Income then rises by a multiple of that rise in investment.
Reason (R): As income rises, households spend a part of the extra income, and this creates fresh excess demand round after round. — True. This is the multiplier process: each rise in income raises consumption, which raises demand again.
A says income rises by more than the rise in investment. R describes the rounds of spending.
Why R explains A? The first rise in investment raises income once. Because households spend part of every rise in income, demand and output rise again in each round. Adding up the rounds gives a total rise in income larger than the first rise in investment.
NCERT (2026-27): “4.3.2 Effect of an Autonomous Change in Aggregate Demand on Income and Output We have seen that the equilibrium level of income depends on aggregate demand. 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 . 2. Change in investment: we have assumed that investment is autonomous. However, it just means that it does not depend on income. There are a number of variables other than income which can affect investment. One important factor is availability of credit: easy availability of credit encourages investment. Another factor is interest rate: interest rate is the cost of investible funds, and at higher interest rates, firms tend to lower investment.” “4.3.3 The Multiplier Mechanism … Hence, in the next round, aggregate demand in the economy goes up by (0.8)10 and there again emerges an excess demand equal to (0.8)10. Therefore, in the next production cycle, producers increase their planned output further by (0.8)10 to restore equilibrium. When this extra output is distributed among factors, the income of the economy goes up by (0.8)10 and consumption demand increases further by (0.8)210, once again creating excess demand of the same amount.” |