Question

a) What factors lead to an increase in Aggregate Demand?

b) If aggregate demand increased with no change to short-run aggregate supply, what would happen to price levels? Briefly explain your answer.

c) What effect would this have on long-run aggregate supply?

Answer 1

a)Interest Rate Decrease

Interest rates help to establish how much consumers pay to borrow. When interest rates are low, consumers tend to purchase a higher volume of goods. As lower interest rates decrease monthly payments, consumers make larger purchases, such as cars and homes, that require loans. Increases in purchases of lower cost goods also are expected. As interest rates decrease, credit-card financing rates are lower and consumers have more disposable income because of lower interest rates on variable rate loans. When the Federal Reserve cuts interest rates, banks and financial institutions typically respond with a similar decrease in the rates offered to borrowers. A decrease in interest rates typically leads to a short-term increase in aggregate demand.

Decrease in Taxes

Reducing taxes increases the amount of available cash that consumers can use to purchase goods and services. The more cash consumers have, the more purchases they are likely make. As consumers in a country increase spending, it directly increases aggregate demand. Tax cuts could decrease individual income taxes, sales taxes or property taxes.

International Involvement

Increases in foreign-based purchases and direct investments can lead to an increase in aggregate demand. Variations in exchange rates can cause the price of foreign-made goods to be cheaper than domestic products. If consumers in another country demand more goods from abroad, their purchases increase aggregate demand in the country where the goods are obtained. The purchases also increase the available cash in the supplying country, which leads to greater consumer spending and an additional increase in aggregate demand. Money also can come in the form of direct investments into companies or raw materials.

Government Expenditures

An increase in government spending on goods and services can increase overall economic demand. The infusion of capital into the economy through government spending leads to increased financial resources in the private sector that injects financial resources into the hands of consumers. When consumers have more disposable cash, aggregate demand increases. Government spending can be for the purchase of goods or services from domestic companies.

b)when the demand curve shift right wards supply remaining the same the equilibrium price will increase and equilibrium quantity will also increase

The demand curve will shift upwards under the following conditions:

1.In the case of normal goods when the income of the consumer increases

c)The laws impact both supply anddemand in the long-run. If quantitydemand increases and supply remains unchanged, a shortage occurs, leading to a higher price until the quantity demanded is pushed back to equilibrium.