Cambridge International as and a level Economics Ebook

Figure 9.19 
A rise in investment in a two-sector economy
Paradox of thrift : 
where the fact of people saving more 
results in a fall in saving due to lower spending and income.
Inflationary gap: 
the excess of aggregate expenditure over 
potential output (equivalent to a positive output gap).
KEY TERMS
Figure 9.20 
Equilibrium income in a four-sector economy
0
Injections and withdrawals
GDP
S + T + M
I + G + X
Y
Figure 9.21 
Impact of a rise in taxation on equilibrium income
0
Injections and withdrawals
GDP
S + T
1
 + M
I + G + X
Y
1
Y
S + T + M
250
Cambridge International A Level Economics

---

Th
e Keynesian solution to a defl ationary gap is increased 
government spending fi nanced by borrowing. 
Figure 9.25 
shows an increase in government spending eliminating a 
defl ationary gap.
Autonomous and induced investment
Investment can rise or fall by signifi cant amounts. 
Investment that is undertaken independently of 
changes in income is known as 
autonomous investment
. 
For example, a fi rm may buy more capital goods because 
it is more optimistic about the future or because the 
rate of interest has fallen. In this case, the aggregate 
expenditure line will shift upwards as shown in 
Figure 9.26.
 
employment of resources. Th
e distance ab represents the 
infl ationary gap.
A government may seek to reduce an infl ationary gap 
by cutting its own spending and/or raising taxation in 
order to reduce aggregate expenditure. 
Figure 9.23 
shows 
a reduction in government spending moving the economy 
back to the full employment level.
Th
e equilibrium level of GDP may also be below the 
full employment level, In this case there is said to be 
a