In an open economy, when income rises during the multiplier process, a part of the induced rise in consumption is a demand for ______. So the multiplier is smaller than in a closed economy.
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → foreign goods
When income rises, people spend more. In an open economy, part of this extra spending goes on imports, that is, on foreign goods.
That part does not raise demand for domestic goods. So each round of the multiplier adds less to domestic income, and the multiplier is smaller.
NCERT (2026-27): “… A change in autonomous expenditures, for instance a change in government spending, will have a direct effect on income and an induced effect on consumption with a further effect on income. With an mpc greater than zero, a proportion of the induced effect on consumption will be a demand for foreign, not domestic goods. Therefore, the induced effect on demand for domestic goods, and hence on domestic income, will be smaller. The increase in imports per unit of income constitutes an additional leakage from the circular flow of domestic income at each round of the multiplier process and reduces the value of the autonomous expenditure multiplier.” |