Correct Option
The correct option is 1 and 3 only.
Explanation
In macroeconomics, a two-sector economy is a simplified model consisting only of households and firms. There is no government sector or foreign trade. In this framework, Aggregate Demand (AD) represents the total demand for final goods and services in the economy at a given price level.
Statement-wise Analysis
- Statement 1 is Correct.
In a two-sector economy, Aggregate Demand is the sum of consumption expenditure by households and investment expenditure by firms. Mathematically, it is expressed as AD = C + I, where 'C' stands for Consumption and 'I' stands for Investment.
- Statement 2 is Incorrect.
In the simplified Keynesian model of income determination, investment expenditure is generally assumed to be autonomous. This means it is independent of the current level of income ($Y$) and is determined by exogenous factors such as business expectations and interest rates. It is denoted as $\bar{I}$. While investment can be induced by income in more complex models, the standard simplified two-sector model assumes it is constant relative to income.
- Statement 3 is Correct.
The consumption function is represented as $C = \bar{C} + cY$. This equation highlights two components:
1. Autonomous Consumption ($\bar{C}$): The minimum level of consumption required for survival, which occurs even when income is zero (financed through past savings or borrowing).
2. Induced Consumption ($cY$): The portion of consumption that depends on the level of income, determined by the Marginal Propensity to Consume ($c$).
Key Takeaway
Aggregate Demand in a two-sector model is the sum of Consumption ($C$) and Investment ($I$). While Consumption has both autonomous and income-induced components, Investment is typically treated as autonomous (independent of income) in the simplified determination of income model.