In an economy, C = 100 + 0.75Y and autonomous investment is 50. Investment now rises to 70. What is the excess demand at the old equilibrium output, and what is the new equilibrium output?
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → Excess demand 20; new output 680
Given:
C = 100 + 0.75Y
I rises from 50 to 70
Old equilibrium output:
\( \displaystyle Y_1 = \frac{100 + 50}{1 - 0.75} = 600 \)
At output 600, find the new AD and the excess demand:
\( AD = 100 + 0.75 \times 600 + 70 = 620 \)
\( \text{Excess demand} = 620 - 600 = 20 \)
So excess demand is 20, equal to the rise in investment. New output:
\( \displaystyle Y_2 = \frac{100 + 70}{0.25} = 680 \)
Option (1) Excess demand 80; new output 680 — Incorrect. The new output is right, but the excess demand at the old output is only 20; 80 is the total rise in output.
Option (2) Excess demand 80; new output 620 — Incorrect. Both figures are wrong; 620 is the new AD at the old output, not the new equilibrium.
Option (3) Excess demand 20; new output 680 — Correct. Excess demand 20, and output rises by 4 × 20 = 80 to 680.
Option (4) Excess demand 20; new output 620 — Incorrect. Output does not stop at 620; the multiplier takes it to 680.
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 Thus, E1 no longer represents the equilibrium.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.” |