Question

Relate the following newspaper headlines to shifts in the C,S,I and AE functions and to changes in equilibrium national income:

1.1 “Consumer’s lack of confidence to the status of the economy leads to a reduction in consumer spending.”

1.2 “The outlook of the economy sounds promising. As a result, inventories rise.”

Answer 1

(1.1)

Reduction in consumer spending (C) will shift consumption function down. As a result, savings (S) will increase, shifting saving function up. Investment (I) will remain the same. Assuming MPC is higher than MPS, downward shift of consumption will be higher than the upward shift in saving, so AE will decrease as net effect and AE function will shift downward, lowering national income.

(1.2)

Increase in inventories will not change C and S, but I will increase, shifting investment function upward. AE will increase, and AE function will shift upward, increasing national income.