Question

5. Suppose that American firms become more pessimistic and decide to reduce investment expenditure today in new factories and office space.

How will this decrease in investment affect output, interest rates, and the current account?

(Please use graphs and explanation Thanks!!)

Answer 1

Aggregate demand = Cpnsumption + Government spending + Investment + Exports - Imports

Pessimistic firm producers reduce the investment level which tends to reduce aggregate demand in an economy which will shift IS curve to its left while LM remains same. It will reduce rate of interest from "i" to "i1" and reduce output level from Y" to "Y1".

Fall in aggregate demand will also reduce price level which will raise exports in an economy because foreign consumers will find our goods comparatively cheaper. Rise in net exports will raise current account.