In the above diagram, what happens if the real GDP is $3 trillion? $5 trillion? $7 trillion? What is the equilibrium level of real GDP? Why?
What will be an ideal response?
At real GDP of $3 trillion, planned real investment is greater than real saving, which means households are buying more than producers had anticipated. There is an unplanned inventory decrease of $500 billion, and businesses increase production and hiring. At $5 trillion, planned real investment and planned real saving are equal, so this is the equilibrium. At $7 trillion, planned real saving is greater than planned real investment so there is an unplanned increase in inventories of $500 billion. Businesses reduce production and lay off workers, forcing real GDP back towards $6 trillion.
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