Question

True or False. If spending exceeds output, real GDP will decline as firms cut back on production.

Short answer

The statement is false.

Step-by-step solution

Step 1. Difference between the real GDP and spending

Real GDP estimates the production of output compared to the base year production at the then price level. It sees the growth of an economy in terms of the output produced rather than the hike in prices.

On the other hand, spending measures the growth of expenditure components in monetary terms. An economy’s spending can change by change in prices or output or both.

Step 2. Reason for the correct statement

When spending exceeds output, it means that the economy is not in equilibrium. There is pressure on the prices (inflation as demand is greater than production). The firms will try to take advantage of this and will increase the supply. Therefore, to bring the economy in equilibrium, firms will try to minimize the size of inventory goods and increase their production.

Therefore, the real GDP will increase because firms expand their output to reach an equilibrium state where spending is equal to output. There is no pressure on the pries.