Problem D Suppose the consumer spending initially rises by $5 billion for every
ID: 1196113 • Letter: P
Question
Problem D
Suppose the consumer spending initially rises by $5 billion for every 1 percent rise in household wealth and that investment spending initially rises by $20 billion for every 1 percentage point fall in the real interest rate. Also assume that the economy's multiplier is 4. If household wealth falls by 5 percent because of declining house values, and the real interest rate falls by 2 percentage points, in what direction and by how much will the aggregate demand curve initially shift at each price level? In what direction and by how much will it eventually shift?
Use the hypothetical economy in the table below to calculate the aggregate demand and supply, as well as its price level.
Given the above information, in this hypothetical economy what is the equilibrium price level and the equilibrium level of real output? Using Excel, graph both the aggregate demand and aggregate supply curves.
Can there be equilibrium level of output at below full employment?
At what price level will aggregate supply equal aggregate demand? At what price level will demand fall below aggregate supply? Given a price level of 250 will aggregate demand exceed supply?
If the aggregate demand schedule shifted by $20 billion to the right at every level, what would be the new equilibrium level of income?
Amount of Real GDP Demand (in billions)
Hypothetical EconomyAmount of Real GDP Demand (in billions)
Price Level (Price Index) Amount of Real GDP Supplied (in billions) $180 300 $500 260 250 400 300 200 300 420 150 200 560 100 100Explanation / Answer
1.
Given the information,
If HH wealth falls by 5%, then consumer spending will increase by 5×$5 = $25 billion
If real interest rate falls by 2%, Investment spending will increase by 2×$20 = $40 nillion
Thus, both consumption and investment will increase, thereby increasing the AD by $25+$40 = $65 billion and shifting the AD curve to the right.
2.
Given the information in the table, equilibrium occurs at the price level where Real GDP demand equals Real GDP supply.
Looking at the table, this comes out to be: P=200 and real GDP = $300 billion.
Yes, equilibrium can exist below full employment, only in the short run.
At P=200, DD=SS
Given a price of $250, SS>DD
If AD shifted by $20 billion, the new equilibrium will be near P=200
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