Suppose that consumer spending initially rises by $5 billion for every 1 percent rise in household...

Suppose that consumer spending initially rises by $5 billion for every 1 percent rise in household wealth and that investment spending initially rises by $20 billion for every 1 percentage point fall in the real interest rate. Also assume that the economy’s multiplier is 3

a. If household wealth falls by 5 percent because of declining house values, and the real interest rate falls by 2 percentage points, in what direction and by how much will the aggregate demand curve initially shift at each price level?

aggregate demand will shift _ (rightward or leftward) by _ billion

b. in what direction and by how much will it eventually shift?

aggregate demand will shift_ (rightward or leftward) by _ billion

Solutions

Expert Solution

a) Intial Increase in the consumer spending as a result of 1 percent increase in the household wealth= $5 billion

Now if the the household wealth falls by 5 Percent because of the declining house values, then

Intial Fall in the consumer spending= 5×5= $25 billion

Initial Increase in the investment spending as a result of 1 percentage point fall in the real interest rate= $20 billion

The real interest rate has fallen by 2 percentage points,

As a result initial increase in the investment spending= 2×20= $40 billion.

Intial Shift in the aggregate demand=intial Increase in the investment spending –Initial fall in the consumer spending= 40–25= $15 billion.

Aggregate demand curve will initially shift rightward at each price level by $15 billion.

b) Economy's multiplier= 3.

Eventual shift in the aggregate demand curve= Economy's multiplier× Initial Shift in the Aggregate demand curve= 3×15= $45 billion.

Aggregate Demand will eventually shift rightward by $45 billion.

Rahul Sunny answered 1 year ago

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