Question

Come up with an example that would affect either C, I or NX that is not caused by a change in domestic price level changing. Based upon your example, how would it shift the AD demand curve? How would your example affect inflation and output of the overall economy in the short run?

Answer 1

Interest rate is an important factor which affects the investment rate. There is an inverse relation between interest rate and investment. If interest rate increased people will tried to save more than investment. This will leads to the reduction of investment rate. This fall in investment leads to fall in productivity level and production. Low investment will not help the firms to purchase more inputs or factor which needed for the production. This will leads to the low rate of production. If every firms in faced the same problem, it will affect the national output and GDP. So rise in interest rate will leads to fall in GDP level. At the same time the interest rate rising will reduce the cost of borrowing and also reduce the level of disposable income. This fall in disposable income reduce the individual consumption level.

This rise in interest rate will shift the aggregate demand curve to left. This shift in aggregate demand will lead to fall in real output level. At the same time the aggregate price level will also fall down. This fall in price will reduce the overall general price level and also leads to deflation. Higher interest rate reduces inflationary pressure and also causes appreciation of the currency. This will leads to export expensive and import at cheaper level. The overall fall in general price level negatively affect the producers also. They will not get desired level of profit. The exchange rate will depreciate and thus this will reduce the overall output and also cause reduction in inflationary pressures.