Question

The short-run equilibrium in the output market is achieved when the value of income from production...

The short-run equilibrium in the output market is achieved when the value of income from
production (output) Y equals the value of aggregate demand D, which is a function of the
real exchange rate, disposable income, investment expenditure and government purchases,
i.e., Y = D(EP*/P, Y-T, I, G). The DD schedule shows combinations of output and exchange
rate at which the output market is in short-run equilibrium.
a) Why does the DD schedule slope upward?
b) List the factors which can shift the DD curve rightwards.

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Answer #1

A.

DD schedule represents the relationship between exchange rate and output. The DD schedule slope upward, because increase in exchange rate, will cause an increase in output level. It happens because increase in exchange rate makes currency to be cheaper that increases the net export. As a result, total output in the economy increases. It makes DD schedule to slope upward.

B.

These factors affecting the DD curve to move in right direction are as follows:

1. Increase in investment demand. It will increase the AD and DD curve will shift to the right.

2. Increase in government spending. It also makes the increase in AD and DD curve will shift to the right.

3. Increase in transfer payments

4. Rise in price in the foreign country or in international market

5.  Lower tax rates in the country, will shift the DD curve to the right.

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