Question

19. Explain and graphically illustrate the effect of a decrease in consumer wealth on consumer spending, aggregate expenditures (AE)

20. Explain and graphically illustrate the effect of decrease in excess capital stock, on investment spending, aggregate expenditures (AE) a

21. Explain and graphically illustrate the effect of increase in consumer debt on aggregate expenditures (AE)

Answer 1

In each graph, initial equilibrium is at point A where initial aggregate expenditure curve (PAE0) intersects 45⁰ line with equilibrium output Y0 and equilibrium aggregate expenditure E0.

(19)

A decrease in consumer wealth will cause consumption demand to decrease. The consumption function will shift downward, lowering equilibrium output and planned aggregate expenditure.

In following graph, initial consumption function is C0. When consumption decreases, C0 shifts downward to C1, causing a downward shift in planned aggregate expenditure curve from PAE0 to PAE1. New equilibrium is at point B where PAE1 intersects 45⁰ line with equilibrium GDP Y1 (< Y0) and equilibrium planned aggregate expenditure E1 (< E0).

(20)

Decrease in capital decreases investment demand. The investment function will shift downward, lowering equilibrium output and planned aggregate expenditure.

In following graph, initial investment function is I0. When investment decreases, I0 shifts downward to I1, causing a downward shift in planned aggregate expenditure curve from PAE0 to PAE1. New equilibrium is at point B where PAE1 intersects 45⁰ line with equilibrium GDP Y1 (< Y0) and equilibrium planned aggregate expenditure E1 (< E0).

(21)

Increase in consumer debt decreases consumption expenditure. The consumption function will shift downward, lowering equilibrium output and planned aggregate expenditure.

In following graph, initial consumption function is C0. When consumption decreases, C0 shifts downward to C1, causing a downward shift in planned aggregate expenditure curve from PAE0 to PAE1. New equilibrium is at point B where PAE1 intersects 45⁰ line with equilibrium GDP Y1 (< Y0) and equilibrium planned aggregate expenditure E1 (< E0).