Consider the following statements about the impact of foreign trade on aggregate demand in India:
Statement 1: Imports by Indian consumers act as a leakage from the circular flow of income hence reducing aggregate demand.
Statement 2: Exports from India to foreign markets act as an injection into the circular flow, increasing aggregate demand.
Show answer & explanation
Correct answer: C
Explanation
The correct answer is option 3 i.e. Both Statement 1 and Statement 2 are correct.
Statement 1: Correct. When Indian consumers purchase foreign goods and services (imports), money flows out of the domestic economy to foreign producers. Since this expenditure does not directly create income or production within India's borders, it acts as a leakage from the circular flow of income, thereby reducing overall domestic aggregate demand.Statement 2: Correct. When Indian businesses sell goods and services to international buyers (exports), foreign currency enters the country. This influx of money brings additional income to domestic producers, which stimulates production and job creation. Therefore, exports act as an injection into the circular flow of income, increasing aggregate demand.