Question

Explain whether each of the following events would increase, decrease, or have no effect on the short-run aggregate demand curve:

a. A decrease in the U.S. price level makes American goods more attractive to foreign buyers.

b. Households decide to consume a larger share of their income.

c. Worsening profit expectations cause firms to decrease their expenditures on new machinery and equipment.

d. As the price level declines, the purchasing power of currency increases, and thus Americans increase their purchases of computers and office equipment.

e. Because of decreasing political tensions in North Korea, the U.S. Congress reduces purchases of jet fighters and tanks.

f. Economic expansion in Europe results in an increase in the European demand for Boeing jetliners.

g. Fearing a future economic downturn, households decide to save a larger fraction of their income.

- Keynesian economists emphasize the effects of fiscal policy on aggregate demand whereas supply-side economists focus on the effects on aggregate supply. Discuss the process by which a tax reduction might result in an increase in real output and employment according to these two approaches. If tax reductions are beneficial for the economy, why doesn't the government slash taxes to zero.

- Assume that the economy's marginal propensity to consume is 0.8. To combat a recession, suppose that the federal government increases its expenditures by $50 billion. If prices remain constant, what impact will this policy have on the economy's aggregate demand and real output? Instead, suppose that prices increase as the economy's aggregate demand increases. What effect would this have on your answer?

Answer 1

a) This will cause increase in exports of U.S.

AD = C + I + G + Exports - Imports

Increase in exports leads to increase in AD.

So, AD increases and shifts AD curve rightwards.

b) This causes increase in C component of AD. So, AD increases.

c) Decrease in business investment means decrease in AD.

d) Increase in Investment causes increase in AD.

e) This causes decrease in government spending i.e. AD decreases.

f) This causes increase in US exports. Increase in exports means increase in AD.

g) Increase in saving means decrease in consumption expenditure i.e decrease in C component of AD. Thus, AD decreases.