Question

Explain why in a multiplier model a rise in household wealth relative to target will ceteris paribus shifts the AD curve upwards and raise output.

Answer 1

When household wealth increases more than the target, it means that with more money in hands than expected, the consumer spendings will increases. An increase in consumer spending will lead to an increase in aggregate demand (since consumer spending is a component of aggregate demand). This will shift the aggregate demand curve upwards.

The multiplier model states that as a result of an increase in consumer spendings or expenditure, the total output will increase by multiple times. In other words, the multiplier model states that as a result of consumer spending, total output increases more than proportionately than the increase in spendings.

Thus, an increase in spendings due to an increase in the household wealth will increase both the aggregate demand and total output of the country.`