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Question

Which one of the following combinations may not render the investment multiplier inapplicable?

This question was previously asked in
UGC NET 2016 Paper 3 Management Question Paper (22-Jan-2017)
The correct answer is

Closed economy, unemployment in the economy, constant marginal propensity to consume.

Concept: The investment multiplier measures how an initial rise in investment produces a larger final rise in income, but it works fully only under ideal conditions; leakages (like imports, taxes and savings) and rigidities weaken or 'render it inapplicable'. The question asks for the combination that does NOT weaken it - that is, the conditions under which the multiplier does work.

Net imports, undistributed profits, taxation, savings, debt cancellation, excess stocks, price inflation and a strong liquidity preference are all leakages or dampeners that reduce the multiplier's effect, so combinations built from them do render the multiplier weak or inapplicable. For example, if households save or import much of the extra income, less of it is re-spent and the multiplier chain quickly dies out.

A closed economy (no import leakage), the existence of unemployment (so extra demand raises output rather than only prices), and a constant marginal propensity to consume (a stable, well-defined multiplier value) are exactly the assumptions under which the simple multiplier holds fully.

Option check: The three options containing imports, taxation, savings, inflation or liquidity preference each carry a leakage that blocks the multiplier, so they are eliminated; only the closed-economy, unemployment, constant-MPC combination is leakage-free.

Hence the combination that does not render the investment multiplier inapplicable is a closed economy, unemployment in the economy, and a constant marginal propensity to consume.

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