In Keynesian cross model, as far as I understand, income-expenditure equilibirum is reached this way: when unplanned inventory investment>0, then firms produce less, when unplanned inventory investment<0 firms produce more. This works just fine ... for small fluctuations. But let's take a different scenario: previously there was income-expenditure equilibrium, but then there happened a significant decrease in the aggregate expenditure. Obviously unplanned inventory investment will be >0, making firms to produce less. But this fall in production will decrease disposable income of households, consequently starting off engine of paradox of thrift. Households will reduce their consumption, consequently shifting the aggregate expenditure curve to new lows. Firms would be getting closer to the equilibirum point by reducing their production, but before they will arrive at it the equilibirum point will "run away", like a hare from wolves, because the aggregate expenditure curve will achieve new low, provoking firms to make yet another cut in order to decrease their unplanned inventory investment. And so on.

Do I understand everything correctly? Is it how the things work?


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