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Chapter 21: Q13 (page 566)

Why do companies cut production when they find that their unplanned inventory investment is greater than zero? If they didn鈥檛 cut production, what effect would

this have on their profits? Why?

Short Answer

Expert verified

Companies cut production in this case, as actual investment is greater than planned investment piles up inventory & increases supply, decreases profits.

Step by step solution

01

Introduction 

Economy's desirable situation is when actual investment = planned investment.

This is ideal, as inventories level are appropriate - neither more, nor less.

02

Explanation 

When unplanned investment is greater than zero, it means actual investment > planned investment. More investment in inventory expenditure implies that inventory levels accumulate & pile up above desired level.

So, firms tend to reduce production to get rid of excess inventory.

  • If they don't cut production, more inventory & supply lead to reduced market prices & profit.

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Most popular questions from this chapter

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).

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

Why does equilibrium output increase as the marginal propensity to consume increases?

If an increase in autonomous consumer expenditure is matched by an equal increase in taxes, will aggregate output rise or fall?
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