When autonomous investment increases in a two-sector model, then

The correct answer is Option (1) → The aggregate demand curve shifts upwards.

In a two-sector model (Households + Firms), the components of aggregate demand (AD) are:

AD=C+I

Where:

• C = Consumption

• I = Investment

When autonomous investment increases, it means investment increases independently of income. This leads to:

• An increase in aggregate demand

• A parallel upward shift in the AD curve, because for every level of income, demand is now higher by the amount of the increased investment

This eventually leads to a multiplier effect on income and output.

Option 2: Output/GDP increases by the same magnitude as the change in investment.

• In a multiplier model, the increase in output (ΔY) is equal to the multiplier (1/(1-MPC)) times the change in autonomous investment (ΔI).

• ΔY = (1 / (1-MPC)) * ΔI.

• Since the MPC (b) is between 0 and 1, the multiplier (1/(1-MPC)) is greater than 1.

• Therefore, the increase in output (ΔY) will be greater than the initial change in investment (ΔI), not the same magnitude. This statement is FALSE.

Option 3: Autonomous expenditure increases by the same magnitude as the change in investment. This statement is also correct. Autonomous investment is a component of autonomous expenditure (A = C̅ + Ī). If autonomous investment increases by a certain amount, then the total autonomous expenditure will increase by that exact amount. However, in the context of typical multiple-choice questions asking for the effect on the model's behavior, the shift in the AD curve is the most suitable answer as it directly sets off the multiplier process.

Option 4:  The consumption curve shifts upwards. This is incorrect. The consumption curve ($C = \bar C+cY$) shifts upwards only if autonomous consumption ($\bar C$) increases or if there is a change in factors influencing consumption behavior independent of income. An increase in autonomous investment affects the investment component of aggregate demand, not the consumption function itself.