Question

Answer question 14 on page 587 (eBook: p.555) under “Problems”,

Chapter 27 – Aggregate Demand in the Goods and Money Markets.

14. Explain the effect, if any, that each of the following occurrences should have on the aggregate demand curve.

a. The Fed lowers the discount rate.

b. The price level decreases.

c. The federal government increases federal income tax rates in an effort to reduce the federal deficit.

d. Pessimistic firms decrease investment spending.

e. The inflation rate falls by 3 percent.

f. The federal government increases purchases to stimulate the economy.

Answer question 14 on page 587 (eBook: p.555) under “Problems”,

Chapter 27 – Aggregate Demand in the Goods and Money Markets.

14. Explain the effect, if any, that each of the following occurrences should have on the aggregate demand curve.

a. The Fed lowers the discount rate.

b. The price level decreases.

c. The federal government increases federal income tax rates in an effort to reduce the federal deficit.

d. Pessimistic firms decrease investment spending.

e. The inflation rate falls by 3 percent.

f. The federal government increases purchases to stimulate the economy.

Answer 1

part (A)

When Fed lowers discount rate, the money supply is increased in the economy.Because the quantity of money supplied is now greater than the amount households want to hold, the equilibrium rate of interest falls. Planned investment spending (which is a component of planned aggregate expenditure) increases when the interest rate falls.

Aggergate demand increases and AD curve shifts rightwards

part (B)

Decrease in price level increases the demand for money. With the supply of money unchanged, the interest rate decreases.  The lower interest rate increases planned investment. Increased planned investment causes downward movement along AD curve

part (C)

Increase in income tax rates by government causes consumption to fall.The lower consumption then decreases planned aggregate expenditure, which leads to fall  in output at each possible price level. AD curve shifts leftwards

part (D)

when pessimistic firms decrease investment spending, planned aggregate expenditure falls. AD curve shifts leftwards

part (E)

Falling inflation rate may encourage people to delay buying expensive goods – hoping they will continue to fall in price – therefore AD may fall. (movement along the AD curve)

part (F)

Increase in spending by federal government increases planned aggregate expenditure, which leads to an increase in output at each possible price level.

AD curve shifts rightwards