CA Foundation · Business Economics · Business Cycles
In a simple economy, the marginal propensity to consume is 0.75. Firms cut planned investment by ₹200 crore as business optimism falls. Assuming no government or foreign sector and no other changes, the total fall in equilibrium income is:
The fall in equilibrium income is ₹800 crore. With an MPC of 0.75 the multiplier is 1 divided by 0.25, which equals 4. Multiplying the ₹200 crore drop in investment by 4 gives ₹800 crore, showing how investment swings amplify business cycles.
- A₹150 crore
- B₹266.67 crore
- C₹800 croreCorrect
- D₹1,000 crore
Explanation
The multiplier is 1/(1 − MPC) = 1/(1 − 0.75) = 4. The fall in income equals 4 × ₹200 crore = ₹800 crore. ₹150 crore multiplies by MPC only, and ₹1,000 crore wrongly uses a multiplier of 5.
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