Question

  3.   Suppose that consumers become pessimistic about the future health of the economy, and so cut back on their consumption spending. What will happen to aggregate demand and to output? What might the government have to do to keep output stable?

            4.   Suppose the Federal Reserve, which is the central bank of the U.S., decided to lower the monetary policy interest rate. Use the macroeconomic model to analyze the possible effects of this event on Canada’s net capital outflow, net exports, and exchange rate. (Hint: Consider the United States a large economy, which is able to influence the world interest rate.)

Answer 1

3) AD= C + I + G + NX

When consumers become pessistic and decrease their consumption spending, C decreases which leads to decrease in aggregate demand. This shifts AD curve leftward to AD'. New equilibrium reaches at e' where price level is lower and output decreases. If the government wants to keep the output stable, it will exercise expansionary fiscal policy that is, the government will increase in government spending or decrease taxes that will shift the AD' curve back to AD, and price level and output return to the initial level.