Solutions final

In terms Of the Keynesian 450 line diagram, such a movement Will be reflected in a downward shift of the consumption function. In the diagram below, the economy is originally in a Keynesian short.

Run equilibrium since planned aggregate expenditure (C 4 IS is just equal to real income or output (Y 1). Firms have no incentive to vary the level of output since they are experiencing neither an unintended increase nor decrease in inventory which would have told them that they were producing too much or too little output.Diagram I However, diagram 2 introduces the downward shift of the consumption function, and, as a consequence, the downward enactment of the planned aggregate expenditure line. Now it can be seen that income and output level Yell is no longer an equilibrium as at that level of output with consumption expenditure rower, planned aggregate expenditure is also lower such that firms are not selling all that has been produced and they are experiencing an unintended increase in inventory. As result firms will adjust by producing less and decreasing output to a new lower level.

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However, diagram 2 introduces the downward shift of the consumption function to CLC, and, as a consequence, the downward movement of the planned aggregate expenditure line to Pate Now it can be seen that income and output level Yell is no longer an equilibrium as at that level of output, with consumption expenditure lower, planned aggregate expenditure is also lower such that rims are not selling all that has been produced and they are experiencing an unintended increase in inventory.The disequilibrium experienced at HI can also be characterized in terms of leakages and injections. Since this is a two- sector model, the only leakage is savings and the only injection is investment expenditure. At Yell. After the decrease in planned aggregate expenditure, intended savings is greater than intended investment although by definition, actual savings is equal to actual investment as the unintended increase in inventory should be considered as unintended investment.

That is, actual investment is equal to planned investment plus the unintended investment in inventory.As a result firms will adjust by producing less and decreasing output to a new lower level until anew equilibrium is reached at which planned aggregate expenditure is equal to output and intended investment is equal to intended savings.