Question

Q. What do you mean by Intertemporal substitution? How does it affects aggregate Demand, discuss in your own words

Q. How does currency gets devalue, what are the reasons and how does it affect overall economic cycle explain in detail.

Q. If you are given following data
    Yd    Consumption
       0 20
      30 30
       50 45
      75 62
      100 80


Can you please draw complete data containing MPS, MPC,AC and AS andl also show consumption function of the last year only.

Answer 1

1. The intertemporal substitution is the effect that shows the change in the quantity demanded of real value of Gross Domestic Product with respect to the change in the opportunity cost of goods and services today in terms of goods and services in the future.

Here the interest rate plays an important role. We know that prices have a negative relationship with the quantity demanded. Now, when the prices rise, the purchasing power of people reduce. Thus the amount that they can lend decreases and the amount to be borrowed increases. Now this supply of loanable funds reduce whereas demand of loanable funds increase,causing an increase in the interest rate. Thus now when the price level increases, ceteris paribus, the interest rate also increases and thus the aggregate demand falls.

2. Devaluation refers to an action taken by the Central Bank to decrease the value of the domestic currency relative to the currencies of the other countries under a system of fixed exchange rate systems. The domestic currency gets devalued when the domestic currency is sold in the foreign exchange market and other currencies are bought.

It takes place when the Central Bank feels the need to take this official action. For example if the country is having a current account deficit then devaluating might benefit the current account deficit if the export revenue increases more than the import bill. Thus the currency devaluation maybe done for increasing the potential export revenues.

However, when this is done, it results in inflation in the economy. As there is more money in the economy, the Central Bank supports the currency and increases the interest rate in order to attract foreign capital in their countries. However if the devaluation is done for too long then it risks the importers and exports become cheaper. Thus devaluation results in larger export revenues.