Which of the following causes a movement downward along the aggregate demand curve?

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Found in: Page 439

Book edition 5th

Author(s) Paul Krugman, Robin Wells

Pages 668 pages

ISBN 9781319098759

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Short Answer

Determine the effect on aggregate demand of each of the following events. Explain whether it represents a movement along the aggregate demand curve (up or down) or a shift of the curve (leftward or rightward).a. A rise in the interest rate caused by a change in monetary policyb. A fall in the real value of money in the economy due to a higher aggregate price levelc. News of a worse-than-expected job market next yeard. A fall in tax ratese. A rise in the real value of assets in the economy due to a lower aggregate price levelf. A rise in the real value of assets in the economy due to a surge in real estate values (adsbygoogle = window.adsbygoogle || []).push({});

1. The aggregate demand shifts leftwards when the interest rate rises due to a change in the monetary policy.
2. The economy moves up along the aggregate demand curve when the real value of money falls due to a rise in aggregate prices.
3. The aggregate demand will shift leftwards because consumers and producers will reduce expenditure at every price level, anticipating a future fall in the job market.
4. When the tax rates fall, the aggregate demand will shift rightwards as people spend more in the economy due to higher disposable incomes.
5. When a lower price level induces an increase in the real value of assets, there is a downward movement along the aggregate demand curve.
6. Owing to a rise in the real value of assets, consumers will have become wealthier, thus, choosing to spend more at every price level. Aggregate demand shifts rightwards in this situation.

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Step by Step Solution

Step 1: Understanding the impact of a rise in interest rates on aggregate demand

The central banks can use monetary policy to alter the interest rate to influence the conditions of an economy.

When the central bank adopts a stringent monetary policy to reduce the money supply in the country, the interest rate is increased. The higher interest rate acts as a disincentive for the people, and they prefer to deposit their money with the banks instead of taking loans.

Further, as interest rates increase, the cost of borrowing for personal consumption increases. Thus, the economy’s money supply reduces as the banks give out lesser loans. Consequently, the people have lower purchasing power, and the aggregate demand curve shifts leftwards.

Step 2: Explaining the effect of a fall in the real value of money due to a price rise on aggregate demand

The aggregate demand curve is a representation of the various aggregate price levels in the economy and the corresponding values of real GDP.

When the aggregate price level rises owing to a fall in the real value of money, there is a movement along the aggregate demand curve. There is an upwards movement that brings the economy to a situation of a higher equilibrium aggregate price level and lower equilibrium real GDP.

When the value of money reduces, people lower their deposits and increase their loans as they wish to hold a higher money endowment. Thus, spending on consumption lessens along with a fall in investment expenditure.

Step 3: Explaining the impact of news regarding future fall in Jobson the aggregate demand

When the people hear the word about the job market in the following year to be worse than they had anticipated, it will trigger a pessimistic attitude.

With a pessimistic attitude, people prefer to save up for the next period by cutting down on consumption in the present period. Thus, consumption and investment expenditure in the present period will fall, and the aggregate demand curve will shift leftwards.

The leftward shift is because people consume and invest a lower proportion of the income at every price level. The people want to keep their living standards unaltered in the following period. Thus, they make adjustments now in anticipation of the poor job market in the future.

Step 4: Explaining the impact of a fall in the tax rate on aggregate demand

A fall in tax rates leads to an increase in the disposable income of consumers.

With an increase in disposable income, consumers would prefer to spend more at every price level in the economy. Thus, the aggregate demand curve would shift rightwards, signifying economic expansion.

Step 5: Understanding the impact of an increase in the real value of assets due to a fall in aggregate price level on aggregate demand

When the real value of assets rises, the people are comparatively wealthier.

When the aggregate price level reduces, the value of the assets increases. Consequently, the wealth endowment of the people increases. Increased wealth endowment implies that the people will have more money to spend in the economy. Thus, there is a downward movement along the aggregate demand curve.

The consumers will spend at a higher equilibrium due to the relatively lower price. Thus, the price will be lower at the new equilibrium, and the real GDP will be higher.

Step 6: Understanding the impact of an increase in the real value of assets due to a surge in real estate values on aggregate demand

When a surgein real estate valuesleads to a consequent rise in the real value of assets, the consumers become comparatively wealthier.

As the people have a comparatively higher wealth, they will consume and investhigher amounts at every price level in the economy. Thus, the aggregate demand will shift rightwards, and the economy will be better.

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