Chapter 12. Economic Fluctuations. Equilibrium. Inventory changes . Unintended changes in inventories cause price levels and real outputs to reach equilibrium. Two possibilities: the results of an inventory increase and of an inventory decrease. An Economy in Equilibrium.
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Unintended changes in inventories cause price levels and real outputs to reach equilibrium.
Two possibilities: the results of an inventory increase and of an inventory decrease.
an unintended increase in inventories; a surplus
Results of an Inventory Decrease
Negative Unplanned Investment:
an unintended decrease in inventories; a shortage
Unplanned investment plays a central role in stabilizing the economy, whether there is an inventory increase or decrease.
Unplanned investment is positive when the price level is above its equilibrium value and negative when the price level is below its equilibrium value, and in each case unplanned investment is identical to the discrepancy between aggregate demand and aggregate supply.
There are 3 reasons the amount saved and the amount invested in an economy is not equal:
If taxes exceed government purchases:
governments can use their excess revenues to pay off some of their outstanding debt.
that means Canadians are spending more on foreign goods than they receive revenue from selling products to foreigners.
comparing these two provides a way of explaining macroeconomic equilibrium that complements the approach using aggregate demand and aggregate supply.
total injections = ( I + G + T )
total withdrawals = ( S + T + M )
Expanding economy: total injections > total withdrawals
flows into the income-spending stream falls are less than output
the income-spending stream falls and slows down
it is possible for equilibrium to occur at the economy’s potential output. In this case, actual unemployment equals the natural unemployment rate
an economy’s real output rarely equals its potential output.
if equilibrium output is below its potential level, unemployment is above the natural unemployment rate.
recessionary gap: the difference between equilibrium output and potential output
if equilibrium output is above its potential output, unemployment is temporarily below the natural unemployment rate.
inflation will accelerate if this situation persists.
Inflationary Gap: when equilibrium output exceeds potential output
·The demand and supply of labour depend on the real wage rate, or wages expressed in constant basted-year dollars, rather than the nominal wage rate, which is valued in current dollars.
·Both workers and employers adjust their behavior only when the purchasing power of wages changes.
·Employers demand less labour at higher real wage rates, while workers choose to supply more.
Voluntary unemployment: when workers decide that real wages are not high enough to make work worthwhile.
·Keynes believed workers were influenced by money illusion.
·Workers would respond to changes in nominal wages, rather than real wages and purchasing power.