Question 1

How do you find equilibrium income mathematically using consumption and investment?

Accepted Answer

Set total planned expenditure equal to output by adding consumption and planned investment at different income levels. Using the consumption function, substitute income values and add fixed investment. Equilibrium occurs where planned spending equals actual output. For example, at $500 income with consumption of $475 and investment of $25, total planned expenditure equals $500 output, confirming equilibrium.

Question 2

What happens to inventory when planned spending exceeds output?

Accepted Answer

When planned expenditure surpasses output, businesses sell goods faster than expected, causing unplanned inventory reduction. This signals the economy is not in equilibrium. Firms respond by increasing production to meet demand and rebuild inventory levels. This adjustment process continues until planned spending aligns with actual output.

Question 3

Why does inventory accumulation occur when output exceeds planned spending?

Accepted Answer

When output surpasses planned expenditure, unsold goods build up because consumers and businesses are purchasing less than what is produced. Firms experience unplanned inventory accumulation, signaling overproduction. In response, businesses typically reduce output levels to match lower demand and prevent further inventory buildup.

Question 4

How does the consumption function relate to finding equilibrium income?

Accepted Answer

The consumption function shows how consumption varies with income, typically as a base amount plus a percentage of income. Combined with fixed planned investment, it determines total planned expenditure at each income level. By comparing this total to actual output using the consumption function, you identify the income level where equilibrium occurs.

Question 5

What role does planned investment play in determining equilibrium?

Accepted Answer

Planned investment is a fixed component added to consumption to calculate total planned expenditure. Unlike consumption, which varies with income, planned investment remains constant regardless of income level. This fixed investment amount, combined with the consumption function, determines whether planned spending equals output at each income level.

Question 6

How can you verify if an economy is in equilibrium using numbers?

Accepted Answer

Compare total planned spending to total output at different income levels. Add consumption and planned investment to get planned expenditure, then check if it equals actual output. When planned expenditure equals output, the economy is in equilibrium and inventory remains stable. Any deviation signals the need for production adjustments.

Question 7

What adjustments occur when the economy moves toward equilibrium?

Accepted Answer

When planned spending exceeds output, unplanned inventory reduction prompts firms to increase production. Conversely, when output exceeds planned spending, unplanned inventory accumulation causes firms to decrease production. These production adjustments continue until planned expenditure equals output, establishing equilibrium income where the economy stabilizes.

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