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-(Figure 7-1: Circular-Flow Model) Use Figure 7-1: Circular-Flow Model. If the circular-flow model is in equilibrium (the sum of money flowing into each box is equal to the sum of the money flowing out of it) and there is an increase in investment spending, holding everything else constant, which outcome is likely to occur?
A) a decrease in GDP
B) an increase in GDP
C) an increase in the unemployment rate
D) a decrease in the inflation rate

Question

Use the following to answer questions: 
-(Figure 7-1: Circular-Flow Model) Use Figure 7-1: Circular-Flow Model. If the circular-flow model is in equilibrium (the sum of money flowing into each box is equal to the sum of the money flowing out of it) and there is an increase in investment spending, holding everything else constant, which outcome is likely to occur?
A) a decrease in GDP 
B) an increase in GDP 
C) an increase in the unemployment rate 
D) a decrease in the inflation rate

Quizplus · Accepted Answer

An increase in investment spending will result in an increase in aggregate demand (AD) and therefore an increase in GDP. This occurs because investment spending is a component of AD, so an increase in investment spending will increase the total demand for goods and services in the economy. Assuming the circular-flow model is in equilibrium, the increase in investment spending will lead to an increase in income and spending, which will allow for the other boxes in the model to balance out with the increased demand. Therefore, there will likely not be a decrease in GDP or an increase in the unemployment rate. While an increase in AD may lead to a slight increase in the inflation rate, it is not significant enough to choose option D as the answer.

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