In the diagram of the fixed price model, autonomous investment rises and the aggregate demand line shifts up from AD1 to AD2. E1 is the old equilibrium on the 45° line, and F is the point on AD2 directly above E1. At the new equilibrium E2, output has risen by E1G. If E1F = 25 and the mpc is 0.75, what is E1G?
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → 100
E1F is the rise in autonomous spending: it is the excess demand at the old output. E1G is the total rise in output. The multiplier links the two.
Multiplier = 1 / (1 − c) = 1 / (1 − 0.75) = 4
E1G = 4 × E1F = 4 × 25 = 100
Option (1) 25 — Incorrect. This takes the rise in output to be equal to the first rise in spending, with no multiplier.
Option (2) 75 — Incorrect. This is the extra consumption over the rounds (100 − 25), not the total rise in output.
Option (4) 33.3 — Incorrect. This divides 25 by the mpc instead of by 1 − mpc.
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 Thus, E1 no longer represents the equilibrium.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.” “4.3.3 The Multiplier Mechanism … The increment in equilibrium value of total output thus exceeds the initial increment in autonomous expenditure. The ratio of the total increment in equilibrium value of final goods output to the initial increment in autonomous expenditure is called the investment multiplier of the economy. Recalling that 10 and 0.8 represent the values of ΔI = ΔA and mpc, respectively, the expression for the multiplier can be explained as”
“where ΔY is the total increment in final goods output and c = mpc . Observe that the size of the multiplier depends on the value of c . As c becomes larger the multiplier increases.” |
