Assume firms become more pessimistic about the future and respond by decreasing investment spending. The Aggregate...

Assume firms become more pessimistic about the future and respond by decreasing investment spending. The Aggregate Demand/Aggregate Supply model suggests that if the Federal Reserve wishes to offset the short run consequences of the decrease in investment it should

Group of answer choices

Decrease the money supply in order to increase interest rates.

Increase the money supply in order to increase interest rates.

Decrease the money supply in order to decrease interest rates.

Increase the money supply in order to decrease interest rates.

Solutions

Expert Solution

As firms become more pessimistic about the future and respond by decreasing investment, this will result in decrease in aggregate demand(AD) and thus AD curve will shift to the left.

Now in order to offset this Federal reserve should change money supply in such a way that will result in rightward shift of AD curve(or increase in aggregate demand).

So, Federal reserve should increase money supply because increase in money supply will shift Money supply curve and LM curve to the right which will result in decrease in interest rate. As investment is inversely related to interest rate. This decrease in interest rate will result in increase in investment an any given price level and thus aggregate demand will increase and AD curve will shift to the right and hence will offset this short run consequence. Thus oprion (d) is the correct answer and rest all are incorrect.

Hence, the correct answer is (d) Increase the money supply in order to decrease interest rates.

Rahul Sunny answered 1 year ago

Next > < Previous

Related Solutions

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

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? (explanation and graphs)

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

Suppose that consumers become pessimistic about the future health of the economy. What will happen to...

Suppose that consumers become pessimistic about the future health of the economy. What will happen to aggregate demand and to output? Show this using AD/AS graphs. What might the president and Congress have to do to keep output stable?

When investors are very pessimistic about the future, investment is not sensitive to interest rates. How...

When investors are very pessimistic about the future, investment is not sensitive to interest rates. How does this affect the IS curve? If the government intends to stimulate the economy, which policy (monetary/ fiscal) will be effective in this case and which will be not? Explain using the LM/IS diagram.

Suppose businesses become pessimistic future of the economy causing businesses to reduce their investments. Use the...

Suppose businesses become pessimistic future of the economy causing businesses to reduce their investments. Use the model of aggregate supply and aggregate demand to show what the Federal Reserve could do to offset the short-run changes in the aggregate supply and aggregate demand model. Explain your answer. HINT: You will need 2 different graphs: a money market graph and the aggregate supply – aggregate demand graph.

Are You optimistic or pessimistic about the future of the Affortable Care Act (now that the...

Are You optimistic or pessimistic about the future of the Affortable Care Act (now that the requirement for everyone to have health insurance has been eliminated? Why or why not?

Suppose that individuals become more optimistic about their future incomes, and increase consumption at their current...

Suppose that individuals become more optimistic about their future incomes, and increase consumption at their current levels of disposable income. Use the Romer model to explain the short-run (immediate) and long-run effects of this law on inflation, output, the real interest rate, consumption, and investment.

Suppose that American firms become more optimistic and decide to increase investment expenditure today in new...

Suppose that American firms become more optimistic and decide to increase investment expenditure today in new factories and office space. a. How will this increase in investment affect output, interest rates, and the current account? b. Now repeat part (a), assuming that domestic investment is very responsive to the interest rate so the U.S. firms will cancel most of their new investment plans if the interest rate rises. How will this affect the answer you gave previously?

Graphically illustrate and explain - what happens to consumer spending when consumers become more optimistic about...

Graphically illustrate and explain - what happens to consumer spending when consumers become more optimistic about the future, i.e., consumer expectations rise - how an increase in the interest rate would affect consumer spending - what happens to consumer spending in response to an increase in consumer income

Please describe the concept of investment spending, as well as what will happen to the aggregate...

Please describe the concept of investment spending, as well as what will happen to the aggregate demand curve if investment spending is increased autonomously. Also provide an example of spending that a macroeconomist would consider “investment spending.”

Subjects