When Output Deviates from the Natural Level of Output, the Economy

question 30

Essay

When output deviates from the natural level of output, the economy is believed to "self- correct" over time. That is, the economy will return to the natural level of output without any policy intervention. First, explain how this process works when output is below the natural level of output. Second, briefly discuss what factors would hinder this self- correcting adjustment when the economy is in a liquidity trap.

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Definitions:

Indirect Method

A method for presenting cash flow from operations that begins with net income and makes adjustments for transactions that do not involve cash.

Statement of Cash Flows

A financial report that shows how changes in balance sheet accounts and income affect cash and cash equivalents, analyzing a company’s financing, investing, and operating activities.

Operating Activities

Transactions related to the primary business activities, detailed in the cash flow statement.

Merchandising Company

A business that purchases finished goods for resale, making a profit on the difference between the sale price and the purchase price.