In the open economy model of income determination, which of the following pairs is correctly matched?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → \( \bar{M} \) – the autonomous component of imports
In the model, imports are M = \( \bar{M} \) + mY, exports depend on foreign income, and both depend on the real exchange rate R.
Option (1) \( \bar{M} \) – the autonomous component of imports — Correct. It is the part of imports, greater than zero, that does not depend on income.
Option (2) m – the fraction of an extra rupee of income spent on consumption — Incorrect. m is the marginal propensity to import: the fraction of an extra rupee of income spent on imports.
Option (3) R – the relative price of domestic goods in terms of foreign goods — Incorrect. R is the relative price of foreign goods in terms of domestic goods; the pair turns it the other way round.
Option (4) Yf – the income of the domestic economy — Incorrect. Yf is foreign income, which decides our exports.
NCERT (2026-27): “DETERMINATION OF EQUILIBRIUM INCOME IN OPEN ECONOMY … Recall that the real exchange rate is defined as the relative price of foreign goods in terms of domestic goods. A higher R makes foreign goods relatively more expensive, thereby leading to a decrease in the quantity of imports. Thus, imports depend positively on Y and negatively on R. 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. …” “M = M + mY, where M > 0 is the autonomous component, 0 < m < 1. (6.5) Here m is the marginal propensity to import, the fraction of an extra rupee of income spent on imports, a concept analogous to the marginal propensity to consume. …” |