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Chapter 21: Q13 (page 566)

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?

Short Answer

Expert verified

Companies cut production in this case, as actual investment is greater than planned investment piles up inventory & increases supply, decreases profits.

Step by step solution

01

Introduction 

Economy's desirable situation is when actual investment = planned investment.

This is ideal, as inventories level are appropriate - neither more, nor less.

02

Explanation 

When unplanned investment is greater than zero, it means actual investment > planned investment. More investment in inventory expenditure implies that inventory levels accumulate & pile up above desired level.

So, firms tend to reduce production to get rid of excess inventory.

  • If they don't cut production, more inventory & supply lead to reduced market prices & profit.

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Most popular questions from this chapter

If firms suddenly become more optimistic about the profitability of investment and planned investment spending rises by \(100 billion, while consumers become

more pessimistic and autonomous consumer spending falls by \)100 billion, what happens to aggregate output?

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)?

“When the stock market rises, investment spending is increasing.” Is this statement true, false, or uncertain? Explain your answer.

During and in the aftermath of the financial crisis of 2007–2009, planned investment fell substantially despite significant decreases in the real interest rate.

What factors related to the planned investment function could explain this?

If the consumption function is C = 100 + 0.75YD, I = 200, government spending is 200, and net exports are zero, what will be the equilibrium level of output?

What will happen to aggregate output if government spending rises by 100?
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