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    Question

    In an economy, households spend a larger proportion of

    every additional rupee of income on consumption rather than saving. As a result, each round of spending generates stronger successive increases in income. Under such conditions, _______ the value of Marginal Propensity to Consume (MPC), _______ will be the size of the Investment Multiplier.
    A Higher, Higher Correct Answer Incorrect Answer
    B Lower, Lower Correct Answer Incorrect Answer
    C Higher, Lower Correct Answer Incorrect Answer
    D Lower, Higher Correct Answer Incorrect Answer
    E Unchanged, Unchanged Correct Answer Incorrect Answer

    Solution

    The Investment Multiplier (k) measures the total increase in national income resulting from an initial increase in investment. The relationship between the multiplier and the Marginal Propensity to Consume (MPC) is defined by the formula: Multiplier (k) = 1/(1-MPC). Because MPC is subtracted from 1 in the denominator, there is a direct relationship between the MPC and the multiplier. As the MPC increases, the denominator (1-MPC) (which represents the Marginal Propensity to Save) becomes smaller. A smaller denominator results in a higher value for multiplier (k). In economic terms, if households spend a larger proportion of every additional rupee, more money is recirculated into the economy during each subsequent round of spending, leading to a much larger cumulative increase in total income.

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