The aggregate demand curve of an economy is parallel to X axis. What will be the value of investment multiplier in this economy?
The aggregate demand curve of an economy is parallel to X axis. What will be the value of investment multiplier in this economy?
Solution
Option 1 -> When AD is horizontal, MPC = 0, so multiplier = 1/(1-0) = 1.
Option 2 -> Zero would mean no change in income from investment, which is incorrect.
Option 3 -> Infinity occurs when MPC = 1, not when AD is horizontal.
Option 4 -> This range doesn't apply when AD curve is parallel to X-axis.
Hence, Option 1: one -> When the aggregate demand curve is parallel to the X-axis (horizontal line), it means aggregate demand remains constant regardless of changes in income/output. This implies that the Marginal Propensity to Consume (MPC) = 0, as consumption doesn't increase with income. Using the multiplier formula: k = 1/(1-MPC) = 1/(1-0) = 1. Therefore, the investment multiplier equals 1, meaning any increase in investment leads to an exactly equal increase in national income with no multiplier effect, since there are no induced consumption rounds. -> correct
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