Question

Each of the following headlines describe an event that will have an effect on desired aggregate expenditure. What will be the effect of equilibrium national income? In each case, describe how the event would be illustrated in the 45 degree diagram.

1. Covit 19 caused millions of lay offs among Canadians.
2. Russia agrees to buy more Canadian wheat
3. High teck firms to cut capital outlays
4. Finance minister pledges to cut tax rates
5. U.S imposes restriction on Canadian lumber.

Answer 1

Aggregate expenditure= Consumption expenditure + Investment expenditure + Government spending + Exports - Imports

Consumption expenditure= Autonomous consumption + MPC(Y-tY)

Here t is the tax rate and Y-tY is the disposable income.

a. Covid 19 cause million of lay offs among Canadian: This will cause people to spend less on consumption which reduces the consumption expenditure as well as national income. As a result AE curve shift downward to AE1. Equilibrium point changes from A to B and equilibrium national income decreases from Y1 to Y2.

b. Russia agrees to buy more Canadian wheat: This means that exports of Canada will increase which will cause rise in AE as well as National income rises. As a result AE curve shift upward to AE1. Equilibrium point changes from A to B and equilibrium national income increases from Y1 to Y2.

c. High teck firms to cut capital outlays: This implies that there will be a decrease in investment expenditure which will cause national income to fall.

As a result AE curve shift downward to AE1. Equilibrium point changes from A to B and equilibrium national income decreases from Y1 to Y2.

d. Finance minister pledges to cut tax rates: A decrease in tax cause disposable income of people to rise so which cause their consumption expenditure to rise. This rise will cause an increase in national income.

A fall in tax rate does not cause intercept on AE to change but it will cause slope of the AE to change and AE curve become more steeper. New AE curve is AE1. The new point of equilibrium is B where national income is Y2 which is more than national income before tax rate change.

e. U.S imposes restriction on Canadian lumber: This restriction means that now Canada can export less to the US so there is a reduction in exports of Canada which cause its AE to fall as well as national income to decrease.

As a result AE curve shift downward to AE1. Equilibrium point changes from A to B and equilibrium national income decreases from Y1 to Y2.