How does a change in the price level alter aggregate spending or consumption, investment and net...

How does a change in the price level alter aggregate spending or consumption, investment and net exports in particular? How do changes in the price level create an aggregate demand curve?

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Expert Solution

Effects of changes in price level:

Aggregate spending/consumption - Price level has an inverse relation with this. When price falls, people consume more goods and services. Similarly, a rise in price level would result in a fall in aggregate consumption.

Investment: When prices falls, usually the interest rate also falls. A fall in interest rate results in an increase in investment rate. Increase in invesment implies a rise in output, income and employment.

Net exports: Just like low prices are attractive to domestic buyers, they are also attractive to international buyers. Therefore, exports will rise and imports will fall (domestic users will also shift to domestically produced goods rather than expensive imported goods). Therefore, net exports will rise.

Aggregate demand curve: Since all the three factors stated above share an inverse relation with price level, all of them combined form the aggregate demand curve which is a downward sloping curve. With an inrease in price level, the output falls and with a fall in price level, the output increases.

Rahul Sunny answered 1 year ago

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