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Chapter 10: Problem 22

What role do inventories play in the equilibrating process in the simple Keynesian model (as described in the \(T E-T P\) framework)?

Short Answer

Expert verified
Inventories in the Keynesian model equilibrate the economy by acting as a buffer between total production and total expenditure. When total production exceeds total expenditure, the surplus goods end up in inventory, and firms subsequently cut back production, moving the economy back towards equilibrium. Conversely, when total expenditure exceeds total production, inventories are depleted and firms respond by increasing production, also moving the economy back towards equilibrium.

Step by step solution

01

Understanding the Keynesian model

The Keynesian model spots the importance of total expenditure in an economy which covers consumption, investments, and net exports. It stresses that total economics spending influences inflation and output.
02

Comprehending the Role of Inventories

Inventories in this context are the goods produced but weren't sold yet. When firms produce more goods than consumers want to purchase (Total Production is more than Total Expenditure), the extra goods are stored as inventories. The rise in inventories causes firms to decrease their production till inventories begin returning to normal levels.
03

Understanding the Equilibrating Process

Equilibrium occurs when total production equals total expenditure (\(T E = T P\)). The inventories play an important role in this equilibrating process. If \(T P > T E\), inventories increase and firms decrease production, leading to a decrease in total production towards equilibrium. If \(T E > T P\), inventories fall and firms respond by increasing production, leading to an increase in total production towards equilibrium.

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Most popular questions from this chapter

According to Keynes, an increase in saving and a decrease in consumption may lower total spending in the economy. But how could that happen if the increased saving lowers interest rates (as shown in the last chapter)? Wouldn't a decrease in interest rates increase investment spending, thus counteracting the decrease in consumption spending?

Using the Keynesian consumption function, prove numerically that, as the \(M P C\) rises, saving declines.

How is Keynes's position different from the classical position with respect to wages, prices, and Say's law?

"In the simple Keynesian model, increases in \(A D\) that occur below Real GDP will have no effect on the price level." Do you agree or disagree with this statement? Explain your answer.

What does the aggregate supply curve look like in the simple Keynesian model?
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