Q. 235.0( 1 Vote )

State whether the

Answer :


Yes, the statement is true. Unplanned inventories accumulate when planned investment is less than planned saving. Planned savings is the intended or planned savings by the households at the beginning of a particular period of time. The total investment that is intended to be made in the economy by the firms at the beginning of a particular period of time is the planned investment.


The economy is in equilibrium when the planned savings equal planned investment. Thus the economy invests whatever it saves. When this equality is not achieved, there can be fluctuations in the level of output. Planned savings can either be less than or more than planned investment.


When the planned savings in the economy is more than planned investment, the households tend to save more than what they consume. Thus the consumption expenditure will be lower in the economy. Thus aggregate demand will be less than aggregate supply. This will result in excess supply in the economy. Thus unintended inventories begin to pile up in the economy. This would be unplanned in nature.


When the unplanned inventories increase, the producers will reduce the employment in the industries. The level of employment and income generation falls. Thus the national income will fall. This will reduce the planned savings until it becomes equal to planned investment and the equilibrium is restored.


(ii)


No, the statement is false. An inflationary gap exists when aggregate demand is greater than aggregate supply at full employment level. The inflationary gap is the gap between the actual output and the potential output in the economy. It is the difference between the actual output and the planned expenditure during a period of time in the economy. The actual output is determined by the employment and the level of technical progress. The planned expenditure is determined by the level of savings and taxation in the system.


The inflationary gap or the expansion gap determines the difference between the actual output and the potential output.



In the following diagram, the level of income in the economy is Y0 at the point of intersection of the C+I and the C+S curves. The equilibrium point at Y0 level of income is E0. When the total investment expenditure in the economy increases, the consumption curve shifts upwards and forms the C+I’ curve. The equilibrium point will be E1 with the equilibrium income being Y1 at the intersection of the C+S curve and the C+I’ curve.


At this point, the actual output in the economy is E0Y0, while the actual expenditure is E1Y1. This difference between the actual and the potential output is the inflationary gap. It is equal to E2E0. This results in inflationary rising prices in the economy.


(iii)


No, the statement is false. Average Propensity to Consume (APC) can never be negative. The total income of the consumer can be divided between consumption and savings. Savings is the residue available with the consumer after providing for consumption expenditure.


Consumption function shows the relationship between consumption and income. The level of consumption is an increasing function of the level of income. As income increases consumption also increases, but less than proportionately. Thus, consumption is an increasing function of income. The consumption curve is an upward sloping straight line. But the curve does not start from the origin. This is because of the existence of autonomous consumption. Autonomous consumption is the level of consumption irrespective of the level of income. This is carried out by dissaving. Thus at the point of dissaving, the APS will become negative.


Mathematically, consumption function can be expressed as:


C=a+ bY; C- level of consumption


a- autonomous consumption


b- Marginal Propensity to Consume (MPS)


Y- the level of income



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