Credit becomes more easily available to firms in a two-sector economy. Which chain of effects follows?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Investment rises → the AD line shifts up in parallel → equilibrium income rises by more than the rise in investment
Easy credit raises autonomous investment. That raises the intercept of AD, so the line shifts up in parallel. Through the multiplier, income rises by more than the rise in investment.
Option (2) Investment rises → the AD line swings up and becomes steeper → equilibrium income rises — Incorrect. The slope of AD is the mpc, which has not changed. So the line shifts in parallel; it does not swing.
Option (3) Investment rises → the AD line shifts up in parallel → equilibrium income rises by exactly the rise in investment — Incorrect. Extra income is partly spent round after round, so income rises by more than the rise in investment.
Option (4) The mpc rises → the AD line swings up → equilibrium income rises by more than before — Incorrect. Credit affects investment, not the mpc.
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.” “4.3.2 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 Thus, E1 no longer represents the equilibrium.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.” |