Put the alternatives given below in the sequence in which they occur to reach the equilibrium level of output given that aggregate demand falls short of aggregate supply.
(A) In this case, the firm has to run down existing inventories, which will lead to a fall in production and hence income.
(B) Stocks will be piling up in the warehouses, causing unintended accumulation of inventories.
(C) Ex-ante demand for final goods falls short of the output of final goods that the producers have planned to produce in a given year.
(D) process continues till Ex-ante demand for final goods equals to ex-ante output of final goods
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → (C), (B), (A), (D)
Output is in equilibrium when planned output equals planned spending on final goods (ex ante aggregate demand). If planned spending is less, some goods stay unsold. Producers then cut production, and the economy moves to a lower equilibrium in these steps:
(C) Ex-ante demand for final goods falls short of the output of final goods that the producers have planned to produce in a given year. — The start: planned spending is less than planned output.
(B) Stocks will be piling up in the warehouses, causing unintended accumulation of inventories. — Unsold goods stay with the firms. This rise in stock was not planned, so it is an unintended accumulation of inventories.
(A) In this case, the firm has to run down existing inventories, which will lead to a fall in production and hence income. — Firms do not want this stock. They cut production and sell from the stock. Lower production means lower wages, rent, interest and profit, so income falls.
(D) process continues till Ex-ante demand for final goods equals to ex-ante output of final goods — When income falls, consumption falls by less than income, because only a part of income is spent. So the gap gets smaller in each round. The fall stops when planned output and planned demand are equal again, at a lower output.
NCERT (2026-27): “4.2 DETERMINATION OF INCOME IN TWO-SECTOR MODEL … Ex ante supply is equal to ex ante demand only when the final goods market, and hence the economy, is in equilibrium. … If ex ante demand for final goods falls short of the output of final goods that the producers have planned to produce in a given year, equation (4.3) will not hold. Stocks will be piling up in the warehouses which we may consider as unintended accumulation of inventories. It should be noted that inventories or stocks refers to that part of output produced which is not sold and therefore remains with the firm. … The inventory investment can take place due to two reasons: (i) the firm decides to keep some stocks for various reasons (this is called planned inventory investment) (ii) the sales differ from the planned level of sales, in which case the firm has to add to/run down existing inventories (this is called unplanned inventory investment).… … But as aggregate demand decreases by 75, it falls short of the output Y*1 = 250 and there emerges an excess supply equal to 75 in the economy. Stocks are piling up in warehouses and producers decide to cut the value of production by 75 in the next round to restore equilibrium in the market. But that would mean a reduction in factor payments in the next round and hence a reduction in income by 75. … The process goes on.…” |