Assertion (A): In the open economy model, a rise in the demand for our exports raises equilibrium income.
Reason (R): Exports depend positively on foreign income and the real exchange rate.
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → Both (A) and (R) are true but (R) is not the correct explanation of (A).
Assertion (A): In the open economy model, a rise in the demand for our exports raises equilibrium income. — True. Exports are part of the demand for domestically produced output, and the export multiplier is 1 ÷ (1 − c + m).
Reason (R): Exports depend positively on foreign income and the real exchange rate. — True. A rise in foreign income raises foreign demand for our goods, and a higher real exchange rate makes our goods cheaper, so both raise exports.
Why R does not explain A?
R only tells us what decides the level of exports; it does not say how exports affect our income. The real explanation of A: a rise in exports is a rise in aggregate demand for domestically produced output, just as a rise in government spending or in autonomous investment would be.
NCERT (2026-27): “DETERMINATION OF EQUILIBRIUM INCOME IN OPEN ECONOMY An increase in demand for our exports is an increase in aggregate demand for domestically produced output and will increase demand just as would an increase in government spending or an autonomous increase in investment. In contrast, an autonomous rise in import demand is seen to cause a fall in demand for domestic output and causes equilibrium income to decline.” “… The export of one country is, by definition, the import of another. Thus, our exports would constitute of foreign imports. It would depend on foreign income, Yf , and on R. A rise in Yf will increase foreign demand for our goods, thus leading to higher exports. An increase in R, which makes domestic goods cheaper, will increase our exports. Exports depend positively on foreign income and the real exchange rate. …” |