Analyzing an Economic Contraction

In an economy experiencing a negative shock to autonomous spending, a downward multiplier process begins, where output and income fall in successive rounds. Why does this process eventually lead to a new, stable, but lower equilibrium, rather than causing income to fall indefinitely?

An economy experiences a sudden, significant decrease in business investment. Arrange the following events to accurately describe the sequence of the downward adjustment process that leads the economy to a new, lower equilibrium.

Evaluating the Impact of a Spending Shock

Tracing the Multiplier Effect

In a closed economy with no government, if the marginal propensity to consume were exactly 1, an initial negative shock to autonomous spending would lead to a continuous and unending decline in aggregate income rather than convergence to a new, lower equilibrium.

An economy with a marginal propensity to consume of 0.8 experiences an initial negative shock from a decrease in autonomous investment of $100 billion. Match each stage of the subsequent adjustment process with the corresponding reduction in aggregate demand for that specific stage.

During a downward multiplier process, the chain reaction of falling income and spending eventually stops and the economy settles at a new, lower equilibrium. This convergence occurs because in each round, the reduction in consumption is only a fraction of the reduction in income, a principle captured by the fact that the ____ is less than one.

Two economies, A and B, are identical except for their households' spending habits. In Economy A, households spend 90% of any new income they receive. In Economy B, households spend 60% of any new income they receive. Both economies experience an identical, unexpected drop in business investment. Which of the following statements accurately analyzes the consequences of this shock for the two economies?

Calculating the Initial Stages of an Economic Contraction