As the price level rises, the purchasing power of households’ real wealth will ,

Question

As the price level rises, the purchasing power of households’ real wealth will , causing the quantity of output demanded to . This phenomenon is known as the effect. When an economy’s price level rises, ceteris paribus, the domestic price level relative to the price level in other countries willrise . This means that domestic exports will be relativelymore expensive than before, while foreign imports will be relativelyless expensive than they were previously. The number of domestic products purchased by foreigners (exports) will thereforefall , and the number of foreign products purchased by domestic consumers and firms (imports) willrise . Net exports will thereforefall , causing the quantity of domestic output demanded torise . This phenomenon is known as theinterest rate effect.

Explanation / Answer

As the price level rises, the purchasing power of households’ real wealth will increase, causing the quantity of output demanded to rise. This phenomenon is known as the rate effect. When an economy’s price level rises, ceteris paribus, the domestic price level relative to the price level in other countries will rise . This means that domestic exports will be relatively more expensive than before, while foreign imports will be relatively less expensive than they were previously. The number of domestic products purchased by foreigners (exports) will therefore fall , and the number of foreign products purchased by domestic consumers and firms (imports) will rise . Net exports will therefore rise , causing the quantity of domestic output demanded to rise . This phenomenon is known as the exchange rate effect.

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