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Chapter 21: Q 5. (page 566)

If households and firms believe the economy will be in a recession in the future, will this necessarily cause a recession, or have any impact on output at all?

Short Answer

Expert verified

Yes, it is likely that if firms & households believe that economy will be in recession - it will trigger recessionary decline in output.

Step by step solution

01

Step 1. Introduction

Recession is the phenomena of decline in overall level of economic activity. It is characterised by two consecutive quarters of economic decline paired with increase in unemployment levels.

02

Explanation 

If households & firms believe that economy will be in recession, they will reduce their planned consumption & investment expenditure respectively.

This will decrease Aggregate Demand. It implies that lesser AD is equal to Aggregate supply at a lower level of income, output & employment.

So, the equilibrium income, output & employment fall - which can create further recessionary tendencies in economy.

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Most popular questions from this chapter

The fiscal stimulus package of 2009 caused the IS curve to shift to the left, since output decreased and unemployment increased after the policies were implemented.” Is this statement true, false, or uncertain? Explain your answer.

Why do companies cut production when they find that their unplanned inventory investment is greater than zero? If they didn’t cut production, what effect would

this have on their profits? Why?

Consider an economy described by the following data:

C=\(4trillionI=\)1.5trillionG=\(3.0trillionT=\)3.0trillionNX=\(1.0trillionf=0

mpc = 0.8

d = 0.35

x = 0.15

a. Derive an expression for the IS curve.

b. Assume that the Federal Reserve controls the interest rate and sets the interest rate at r = 4. What is the equilibrium level of output?

c. Suppose that a financial crisis begins and f increases to f = 3. What will happen to equilibrium output? If the Federal Reserve can set the interest rate, then at what level should the interest rate be set to keep output from changing?

d. Suppose the financial crisis causes f to increase as indicated in part (c) and also causes planned autonomous investment to decrease to I = \)1.1 trillion. Will the change in the interest rate implemented by the Federal Reserve in part (c) be effective in stabilizing output? If not, what additional monetary or fiscal policy changes could be implemented to stabilize output at the original equilibrium output level given in part (b)?

If an increase in autonomous consumer expenditure is matched by an equal increase in taxes, will aggregate output rise or fall?

In each of the following cases, determine whether the IS curve shifts to the right or left, does not shift, or is indeterminate in the direction of shift.

a. The real interest rate rises.

b. The marginal propensity to consume declines.

c. Financial frictions increase.

d. Autonomous consumption decreases.

e. Both taxes and government spending decrease by the same amount.

f. The sensitivity of net exports to changes in the real interest rate decreases.

g. The government provides tax incentives for research and development programs for firms.
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