Question

Refer to Book “Principle of Economics” by Karl E.Case, Ray C.Fair and Sharon M.Oster, 10th Edition, 2012, Pearson International Publishing House

Chapter 27 – Aggregate Demand in the Goods and Money Markets. Question #14 on page 587 under “Problems”,

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

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

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a. The Fed lowers the discount rate.

Since the discount rate is lowered, borrowing becomes cheaper. This will shift the aggregate demand curve to the right, as it will increase at all price levels.

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b. The price level decreases.

If the price level decreases, there will be an increase in the quantity demanded of output. There will be a rightward movement along the aggregate demand curve.

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

If the income tax rates increase, income levels in the country will fall. This will shift the aggregate demand curve to the left, as it will decrease at all price levels.

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d. Pessimistic firms decrease investment spending.

If firms decrease investment spending, investment levels in the country will fall. This will shift the aggregate demand curve to the left, as it will decrease at all price levels.

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e. The inflation rate falls by 3 percent.

If the inflation rate falls, it implies that purchasing power rises. Expenditures in the economy will rise, and it will shift the aggregate demand curve to the right.

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

If government purchases increase, it will shift the aggregate demand curve to the right, as it will increase at all price levels.