Aggregate Expenditure Model: Inventory and Output Adjustment

Consider Planned Aggregate Expenditure Model:

If the equilibrium GDP is $2 trillion, but GDP is temporarily $1.6 trillion, what will happen to inventories and output?

Answer:

If the equilibrium GDP is $2 trillion but the GDP is temporarily $1.6 trillion, there is a gap between actual output and the desired level of output. This means that Inventories would decrease and output would increase. The correct option is C.

The adjustment in output and inventories in the planned aggregate expenditure model is crucial for restoring equilibrium in the economy. When the actual GDP falls below the equilibrium level, there is excess supply in the market, leading to a decrease in inventories.

Businesses will respond by increasing output to bridge the gap between actual GDP and the equilibrium level of $2 trillion. As output increases, inventories will decrease until they reach a level that aligns with the intended level of spending in the economy.

This adjustment process is essential for maintaining stability and balance in the economy. By ensuring that supply matches demand, businesses can avoid overproduction or underproduction, thereby promoting economic growth and stability.

Therefore, the correct answer is option C, where inventories decrease and output increases in response to the temporary GDP shortfall.