10.The aggregate demand curve shows the relationship between the overall price l
ID: 1124058 • Letter: 1
Question
10.The aggregate demand curve shows the relationship between the overall price level and the level of total demand for GDP. It is downward sloped to the right. So, it shows that Price level and GDP demanded are inversely related. Three effects of price change are used to explain the negative slope of the AD curve. They are: wealth effect, interest effect and foreign purchase effect. Please what wealth effect means.
11.Components of aggregate demand:
Aggregate demand means demand for the GDP in the economy. There are four types of demand:
Households consumption (C), Firms private investment (I), Government purchases (G) and Foreigners’ demand (NX). So, AD = C+I+G+NX.
Please explain how will the AD curve shift:
(I) if there is a decrease in consumer confidence, how will it change the AD curve? .
(ii) if government decreases its military spending
(iii) if interest in the economy falls
12.Marginal Propensity to consume:
If the marginal propensity to consume (MPC) was 0.8, it would mean that consumers spend $80 out of every $100 of additional disposable income. That means consumers save $20 of of every $100 of additional disposable income. So, the marginal propensity of saving ( MPS) is 0.2.
So, MPC+MPS = 1.
Government spending multiplier is = 1/ (1-MPC).
Please answer:
(i) If the MPC were to decrease from 0.8 to 0.5, what will be the change in government spending multiplier?
When any money is spent by the government in the economy, that money changes hands and total spending is more than the initial spending. Say, if initial spending is $500 and spending multiplier is 10, total amount of money spent in the economy is approximated to be $500x10 = $5000 (initial spending x spending multiplier = total spending) .
Say, if the economy needs $1000bn spending, and if the MPC is 0.8, answer the followings:
(i) What is the spending multiplier ?
(ii) how much should be the increase in government spending?
13.Fiscal policy are of two types: Expansionary and contractionary.
To regulate the economy , a government can do use two tools: change government spending (G) or Tax. To expand the economy, government uses expansionary fiscal policy. To shrink the economy, it uses contractionary fiscal policy.
Please answer: what type of fiscal policy is the conducting
(i) the government increases its spending
(ii) if the government increase taxes,
14.Discretionary and Automatic Fiscal policies:
When output deviates from potential GDP, automatic stabilizers work to push the economy in the same direction that correctly timed and formulated discretionary policy would.
Please answer:
(i) what does discretionary fiscal policy mean?
(ii) what does automatic fiscal policy mean?
15.Monetary Policy and the Federal Reserve:
The Federal Reserve is the central bank of the United States. The Federal Reserve is fairly independent of the rest of government. Its main function is to manage money supply in the economy such that it achieves the twin goals of full employment and price stability. If the Fed wishes to expand economic activity, it might actively pursue expansionary monetary policy. If the Fed wishes to slow economic activity, it might actively pursue contractionary monetary policy. The Fed can control the money supply by altering the followings: open market operations, required reserve ratio (RRR) and discount rate. Of these three, by far the most commonly used tool is ‘open market operation’.
Open Market Operations: Open market operations involve the purchase and sale of government bonds by the Federal Reserve System to banks or the general public.
The Reserve Requirement: The reserve ratio is the portion of depositors' balances that banks must have on hand as cash, which cannot be loaned out. This is a requirement determined by the Fed.
The Discount Rate: Banks having trouble meeting their reserve requirement can borrow funds directly from the Fed at its discount window. The interest rate the Fed charges on these short term lendings to commercial banks is called the discount rate.
Please answer what type of monetary policy does the Fed conduct if it:
(i) sells government bonds to the public
(ii) lowers discount rate
(iii) increases required reserve ratio.
Explanation / Answer
(10)
When price level decreases (increases), purchasing power of money increases (decreases) and therefore, real wealth of consumers increases (decreases). As a result, consumers increase consumption demand, and quantity of aggregate output demanded increases, giving the AD curve a negative slope. This is the wealth effect (the term coined by Pigou).
(11)
(i) If consumer confidence decreases, people lower consumption, so consumption demand falls, decreasing aggregate demand. The AD curve shifts leftward.
(ii) If government decreases military spending, total government expenditure decreases, thereby decreasing aggregate demand. The AD curve shifts leftward.
(iii) If interest in the economy** falls, investor confidence falls, which decreases business investment demand, thereby decreasing aggregate demand. The AD curve shifts leftward.
**If the question means Interest rte in the economy falls, in that case lower interest rate will increase investment demand and the portion of consumption demand funded by borrowing. As a result, aggregate demand will increase. AD curve will shift rightward.
NOTE: As per Chegg answering policy, first 2 questions are answered.
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