The following hypothetical situation and the assumptions of the Simple Keynesian

Question

The following hypothetical situation and the assumptions of the Simple Keynesian model are to be used in answering this question. The economic system is currently producing goods and services at an annual level of $900 billion. Household consumption is running at $500 billion; business firms spend their planned amount of $200 billion on new plant and equipment; and government is also purchasing goods and services at the $200 billion level. Net exports equal zero. The natural level of output is estimated to be $1100 billion. Left to its own decisions, businesses will react to this situation by

a. Increasing real output above the current level

b. Decreasing real output below the current level

c. Holding real output at the current level

d. Increasing plant capacity

Explanation / Answer

Left to its own decisions, businesses will react by holding real output at the current level because the total goods and services produced are equal to the total goods consumed by households, businesses, and government. Hence the correct answer is (C) i.e holding real output at the current level.

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