Vicious Circle of Low Capacity Utilization and Demand
When firms' investment decisions are interdependent, a pessimistic outlook on future demand can create a self-perpetuating vicious circle. If firms expect low demand, they will not invest or hire, leading to low capacity utilization and profits. This suppresses overall income and spending, which in turn validates the initial pessimistic expectations. This situation represents a coordination problem: firms are trapped in a low-activity equilibrium, even though they would all be better off if they could coordinate to invest simultaneously.
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Introduction to Macroeconomics Course
Ch.3 Aggregate demand and the multiplier model - The Economy 2.0 Macroeconomics @ CORE Econ
The Economy 2.0 Macroeconomics @ CORE Econ
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Vicious Circle of Low Capacity Utilization and Demand
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An economy is experiencing a widespread slowdown in consumer spending. In response, the central bank makes a highly publicized announcement that it will lower its main policy interest rate, stating the goal is to ensure a strong economic recovery. How would a forward-looking, profit-maximizing firm most likely analyze this situation when deciding whether to undertake a major investment in new equipment?
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A rational, profit-maximizing firm's decision to invest in new production capacity is based exclusively on its current profitability and the current cost of borrowing.
Match each economic signal with the most likely resulting expectation and investment decision for a typical firm.
A company is considering a significant investment to expand its production capacity. The company's managers observe that several of their main competitors have recently announced large-scale hiring plans and have begun purchasing new capital equipment. Assuming the company's goal is to maximize future profits, how should its managers interpret the competitors' actions when deciding whether to proceed with their own expansion?
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An economy is experiencing a slowdown. Arrange the following events in the most likely logical sequence that would lead to a recovery driven by business investment.
Strategic Investment Amid Conflicting Economic Signals
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Learn After
Example of a Vicious Circle in a Two-Firm Economy
Virtuous Circle of Coordinated Investment and Demand
Figure 3.21: Vicious Circle from Low Expected Demand
Coordination Problem in Investment Decisions
Analyzing Economic Stagnation in a Manufacturing Town
An economy is experiencing a period of stagnation. Arrange the following events to correctly illustrate the self-perpetuating cycle that traps the economy in a low-activity state.
In a regional economy, most businesses are operating with significant unused production capacity. They are reluctant to invest in expansion or hire new employees because they do not expect sales to increase. Consequently, local household incomes remain low, and consumer spending is weak. Which statement best analyzes the underlying reason this situation is self-perpetuating?
In an economy where numerous firms are simultaneously operating with low capacity due to weak overall demand, a single, rational firm is likely to break this cycle by independently increasing its investment and production.
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The Self-Perpetuating Nature of Economic Stagnation
Match each economic condition or action with its most direct consequence in the context of a self-perpetuating economic cycle.
When many firms in an economy operate with significant unused production capacity, it leads to lower profits and incomes. This, in turn, suppresses overall ____, which reinforces the firms' initial decision not to expand, trapping the economy in a state of stagnation.
An economy is characterized by widespread low capacity utilization, where most firms could produce more but choose not to. This has led to stagnant incomes and persistently weak consumer spending. A government advisor argues that the most effective way to break this cycle is to provide a large investment subsidy to a single, major manufacturing firm, believing its expansion will 'kick-start' the rest of the economy. Evaluate the likely outcome of this specific policy.
Evaluating a Policy to Combat Economic Stagnation