Circular flow of income: two-sector model

Correct answer: A. Inventories may fall because demand rises

Explanation: An increase in autonomous investment raises aggregate expenditure directly. When MPC is high, much of the additional income is quickly spent, producing a strong increase in demand. If firms cannot raise output immediately, sales may exceed current production and inventories will be drawn down. This is a possible short-run signal, not an unavoidable outcome.

Correct answer: A. First compare S and I, then identify the direction of inventory and output adjustment

Explanation: In the two-sector model, planned saving S and planned investment I are central indicators of equilibrium. If S exceeds I, firms face an unintended accumulation of inventories and may reduce output; if I exceeds S, inventories tend to fall and firms may expand output. The same process should be located on the diagram by tracing the movement toward or away from equilibrium income.