In an open economy, the marginal propensity to consume is 0.75 and the marginal propensity to import is 0.25. The government raises its purchases by Rs 60 crore; exports do not change. Which of the following is correct once the multiplier process is complete?
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → Income rises by Rs 120 crore, and net exports fall by Rs 30 crore.
In an open economy, part of each extra rupee is spent on imports, so the multiplier is 1 ÷ (1 − c + m). As income rises, imports rise by m times the rise in income, while exports stay the same.
Given:
c = 0.75
m = 0.25
ΔG = Rs 60 crore
\( \displaystyle k = \frac{1}{1 - 0.75 + 0.25} = \frac{1}{0.5} = 2 \)
\( \displaystyle \Delta Y = 2 \times 60 = 120 \)
\( \displaystyle \Delta M = 0.25 \times 120 = 30 \)
\( \Delta NX = -30 \)
Income rises by Rs 120 crore and net exports fall by Rs 30 crore.
Options (1) and (4) — Rs 240 crore uses the closed economy multiplier, 1 ÷ (1 − c) = 4.
NCERT (2026-27): “… Here m is the marginal propensity to import, the fraction of an extra rupee of income spent on imports, a concept analogous to the marginal propensity to consume. …” “… Since m, the marginal propensity to import, is greater than zero, we get a smaller multiplier in an open economy. …” |