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Chapter 21: Q 8. (page 566)

If firms suddenly become more optimistic about the profitability of investment and planned investment spending rises by \(100 billion, while consumers become

more pessimistic and autonomous consumer spending falls by \)100 billion, what happens to aggregate output?

Short Answer

Expert verified

There is no change in Aggregate output.

Step by step solution

01

Step 1. Introduction

Aggregate output is determined at equilibrium level, where Aggregate Demand = Aggregate Supply.

Aggregate Demand comprises of planned expenditure by sectors of a closed economy : consumption expenditure by households, investment expenditure by firms, government spendings by government.

AD = C + I + G

02

Explanation 

If firms' planned investment expenditure increase, & households' planned consumption expenditure reduces : Simultaneous increase & decrease in components of Aggregate demand nullify each other, imply that AD remains constant.

So, the equilibrium level of income & output also remains same.

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Most popular questions from this chapter

鈥淲hen the stock market rises, investment spending is increasing.鈥� Is this statement true, false, or uncertain? Explain your answer.

Assuming both taxes and government spending increase by the same amount, derive an expression for the effect on equilibrium output.

Consider an economy described by the following data:

C=\(3.25trillionI=\)1.3trillionG=\(3.5trillionT=\)3.0trillionNX=-\(1.0trillionf=1

mpc = 0.75

d = 0.3

x = 0.1

a. Derive simplified expressions for the consumption function, the investment function, and the net export function.

b. Derive an expression for the IS curve.

c. If the real interest rate is r = 2, what is equilibrium output? If r = 5, what is equilibrium output?

d. Draw a graph of the IS curve showing the answers from part (c) above.

e. If government purchases increase to \)4.2 trillion, what will happen to equilibrium output at r = 2? What will happen to equilibrium output at r = 5? Show the effect of the increase in government purchases in your graph from part (d).

In each of the following cases, determine whether the IS curve shifts to the right or left, does not shift, or is indeterminate in the direction of shift.

a. The real interest rate rises.

b. The marginal propensity to consume declines.

c. Financial frictions increase.

d. Autonomous consumption decreases.

e. Both taxes and government spending decrease by the same amount.

f. The sensitivity of net exports to changes in the real interest rate decreases.

g. The government provides tax incentives for research and development programs for firms.

鈥淪ince inventories can be costly to hold, firms鈥� planned inventory investment should be zero, and firms should acquire inventory only through unplanned inventory

accumulation.鈥� Is this statement true, false, or uncertain? Explain your answer
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