Answer to Question #274213 in Macroeconomics for Faza andika

Question

1.     Define carefully what is meant by equilibrium in the multiplier model. For each of the following, state why the situation is not an equilibrium. Also describe how the economy would react to each of the situations to restore equilibrium.

a)     In Table 22-2, GDP is $3300 billion

b)     In Figure 22-7, actual investment is zero and output is at M.

c) Car dealers find that their inventories of new cars are rising unexpectedly

Answer 1

The multiplier is the change in income that occurs because of the changes in the components of aggregate demand. The aggregate demand consists of the four components that are consumption, investment, government expenditure, and net exports.

Equilibrium is achieved in the economy when the aggregate demand is equal to the aggregate supply. The price and wages in the short run are taken as fixed as price and wages remain sticky in the short run. The equilibrium is achieved where aggregate demand is equal to aggregate supply.

(a) If the GDP is $3300 billion, the aggregate demand is greater than the aggregate supply. This leads to an unplanned decrease in inventory of unsold stock. The firms will react to it by increasing production and output. The output is increased until the firm reaches equilibrium where aggregate demand is equal to aggregate supply.

(b) If the actual investment is zero and output is at point M. The aggregate demand will be represented by the consumption as the investment is zero. The aggregate supply is greater than the aggregate demand. There is an unplanned increase in the inventory of unsold stock. The firm will reduce output and production until the firm reaches equilibrium.

(c) If the inventory of a good rise, the aggregate supply is greater than aggregate demand. This leads to an unplanned increase in the inventory of unsold stock. The firm will reduce output and production until the firm reaches equilibrium.