"In a hypothetical economy, planned savings fall short of planned investments, leading to fall in employment and income." Do you agree with the given statement ? Support your answer with a valid explanation.

Question

Accepted Answer

Yes, I agree with the statement. When planned savings fall short of planned investments (S < I), it means households are consuming more than firms expected. This leads to:

1. Unplanned decrease in inventories: Since consumers buy more than expected, firms' stock of goods falls below the desired level.
2. Firms respond by increasing production: To restore inventories to the desired level, firms increase output.
3. Income and employment rise: Increased production leads to higher employment and income.
4. Savings increase with income: As income rises, saving also rises (since MPS > 0).
5. Process continues until S = I: The economy adjusts until planned savings equal planned investment, establishing a new equilibrium at a higher income level.

Thus, the economy moves towards equilibrium through a process of inventory adjustment and output changes.