Suppose the economy is experiencing a recessionary output gap. What has happened to planned aggregate expenditure?...

Suppose the economy is experiencing a recessionary output gap. What has happened to planned aggregate expenditure? What might have caused this change?

Expert Solution

Aggregate expenditure is the total amount spent for the economy's output by all households, firms, foreigners, and the government. Prices are determined by the equilibrium between aggregate demand and aggregate supply, but aggregate expenditure is the amount actually spent, revealing actual demand at current prices and aggregate supply.

When aggregate expenditure is less than aggregate output, inventories will increase and prices will fall. Firms will lower production and lay off workers to save on costs and lower prices to sell their inventory. If the resulting aggregate output is less than potential output, then this will cause a recessionary output gap, leading to a fall in employment and inflation. Causes leading to above scenario may be,

Real GDP falling below potential output.
Workers have a relatively low amount of bargaining power with employers.
The demand for all factor services are relatively low.

Rahul Sunny answered 2 years ago

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