Using the 45-degree line diagram below, at point A, what happens to inventories, and as a result what will happen to production in the economy?

Question

BlackTom AI · Accepted Answer

To analyze this question, I will examine what a point A movement on the 45-degree line diagram implies for inventories and production.

Option 1: There is an unplanned decrease in inventories, and therefore production will decrease. A fall in inventories would normally signal stronger than expected demand and would typically trigger an increase in production, not a decrease, so this option seems inconsistent with the standard interpretation of inventory changes as a signal to adjust output upward.

Option 2: There is an unplanned increase in inventories, and therefore production will decrease. An unplanned build-up in inventories suggests demand is weaker than expected, so firms would reduce production to avoid overproducing. This reasoning is plausible, but it conflicts with the depicted point A in which the implied adjustment leads toward higher output rather than lower.

Option 3: There is an unplanned increase in inventories, and therefore production will increase. An increase in inventories would normally lead to a reduction in production, since unsold goods imply overproduction. Increasing production in response to rising inventories would be contradictory to the typical dynamic shown by inventory adjustments.

Option 4: There is an unplanned decrease in inventories, and therefore production will increase. When inventories fall unexpectedly, it means demand is stronger than what was planned, so firms respond by increasing production to rebuild inventories and meet the higher demand. This aligns with the standard accelerator/multiplier intuition where a negative inventory shock prompts output to rise.

In summary, the core idea is: an unplanned decrease in inventories signals higher than expected sales, which triggers an increase in production to prevent further inventory drawdown and to satisfy demand. The other options either reverse the causal link (inventory increase prompting more production) or contradict the general rule that falling inventories push production up rather than down.

ECON 2002.01 AU2025 (21333) Final Exam- Requires Respondus LockDown Browser

Using the 45-degree line diagram below, at point A, what happens to inventories, and as a result what will happen to production in the economy?

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