Figure3showstheeconomysadjustmentsasaresultofthenewpae

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Unformatted text preview: e net tax decrease is saved), the overall effect is to shift the withdrawals schedule downwards to W1. Figure 3 shows the economy’s adjustments as a result of the new PAE and withdrawals schedules. Immediately after these shifts, the economy’s income will still be at Y0e . Given this level of income, the relevant points on the new withdrawals schedule, W1, and the new PAE schedule, PAE1, are shown by, respectively B’ and B; the economy is still at A’ on the planned injections schedule. At B’, withdrawals are less than planned injections. Likewise, at B, GDP is less than planned aggregate expenditure (households are planning to increase their spending as a result of the stimulus package). This implies that firms will be unable to meet demand at their current levels of production. Hence there will be an unplanned decrease in inventories. This unexpected inventory change acts as a signal to firms that they should increase production, thus raising GDP. The resulting increase in income induces an increase in withdrawals and consumption, resulting, respectively, in movements along the withdrawals and PAE schedules, as shown in Figure 3. This continues until PAE and production (or withdrawals and planned investment) are again brought into equilibrium – see Figure 3. This new equilibrium is given by t...
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