Question

True , False or Unsertain( diagrams needed pls)

A5-6. Ceteris paribus, an increase in the domestic price level increases the price of domestic goods increases relative to foreign goods resulting in a downward shift of aggregate expenditures and a leftward shift of the aggregate demand curve.

A5-7. An economy with only price taking firms will have a horizontal short-run aggregate supply curve.

Answer 1

The marginal propensity to consume (MPC) is the additional amount of consumption results from one additional unit of income. This is given as

……. (1).

Here is change in consumption; and is change in disposable income. The MPC lies between 0 to 1.

The aggregate expenditure of the economy is consumption plus government expenditure plus investment expenditure plus net export. That is

.

For simplicity me assume that apart from consumption all other component of aggregate expenditure are autonomous. Thus the aggregate expenditure depends on the consumption function. The slope of the aggregate expenditure is equal to MPC..

In equilibrium aggregate expenditure is equal to total output. To determine this we draw a 45° line, each point on this line indicates. The slope of the 45° line is 1, the slope of AE line is MPC which lies between 0 and 1. Thus the AE line cut the 45° line from below and equilibrium occurs at the point where the AE schedule cut the 45°line. This is shown in the figure below; here the AE line cut the 45°line at E, the equilibrium occurs at E.

As the relative price of domestic good increases, imports becomes dearer and export becomes expensive. This increases import and decreases export. Thus, the net export, given as NX, falls. This decreases the autonomous part of the aggregate expenditure AE.

The aggregate demand is the inverse relationship between price level and the real GDP. As price level falls the goods and services become cheaper and the people consume more. The aggregate expenditure curve shifts upward and real GDP increases. Thus as price level fall the real GDP increases.

Now if the autonomous part of aggregate expenditure falls, this also causes the aggregate expenditure curve to shifts down. As the AE curve shifts the real GDP decreases. A fall in demand moves the economy along the SRAS and the price level and reag GDP falls at the same time.

Hence when the autonomous part of the AE curve decreases the AE curve and the demand curve both shifts downward.

The statement is : TRUE