National income and price determination - Aggregate demand curve

Question 1

What is the aggregate demand curve

Answer 1

demand for everything

Question 2

Why is the aggregate demand curve downward sloping, 3 reasons:

Answer 2

1. real wealth effect
2. interest rate effect
3. exchange rate effect

Question 3

Why is the aggregate demand curve downward sloping

Answer 3

b/c there is a negative relationship b/w price level and real GDP
- price level goes up, they can’t buy as much they did b/4, their assets have less value

Question 4

Explain wealth effect

Answer 4

• higher price levels reduce purchasing power of money
• decreases the qty of expenditures (buy less)
• lower price levels increase purchasing power and increase expenditures

Question 5

Explain interest rate effect

Answer 5

• when the price level increases, lenders need to charge higher interest rates to get REAL return on their loans

Higher interest rates
- discourage consumer spending and business investment

Question 6

Explain Foreign trade effect

Answer 6

• when US price level rises, foreign buyers purchase fewer us goods and americans buy more foreign goods
• exports fall and imports rise causing real GDP demand to fall (Xn Decreases)

Xn - net exports

Question 7

What are the compoents for the Aggregate demand that shifts the curve

Answer 7

1. C - Consumer spending
2. I - Investing (business spending)
3. G - Gov. Spending
4. Xn - net exports

Question 8

What is the formula for Shifter componets for aggregate demand

Answer 8

C+I+G+Xn

Question 9

What is the Multiplier effect

Answer 9

the initial change in spending causes a higher change in spending in the economy why?

b/c one person’s spending becomes someone else’s income

• that person saves a portion and spends the rest, which becomes someone elses income

Question 10

What is MPS

Answer 10

Marginal Propensity to Save

Question 11

Explain MPS

Answer 11

How much people save rather than consume when there is a change in disposable income

Question 12

What is the formula for MPS and how is it expressed

Answer 12

MPS = change in savings / change in disposable income

expressed as a fraction (decimal)

Question 13

What is MPC

Answer 13

Marginal propensity to consume

Question 14

explain MPC

Answer 14

how much people consume rather than save when there is a change in disposable income

Question 15

What is the formula for MPC and how is it expressed

Answer 15

MPC = Change in consumption / change in disposable income

• always expressed as a fraction (decimal)

Question 16

What are the simple spending multiplier formulas

Answer 16

1 / MPS or

1/ (1-MPC)

Question 17

What is the simple tax multipler formula

Answer 17

MPC X (1/MPS) or

MPC / MPS