Chapter 10, Problem 1CQ

(a)

To determine

Identify the impact on the aggregate demand when increased fear of recession.

Explanation of Solution

The components of the aggregate demand are the consumption expenditure, government spending, investment, and net exports. The factors influenced by the change in aggregate demand are the expectation, fiscal and monetary policy, and world economic changes. The recession is the situation of a temporary fall in the economic activity, which causes loss of jobs and fall in the price level. Hence, in the future, without any income, consumption and investment would not be possible. Therefore, the people in Country U will cut down their current consumption and investment. Since a fall in the current consumption and investment will lead to reduce the current aggregate demand.  

Economics Concept Introduction

Aggregate demand: The aggregate demand is the total demand for the goods and services produced by a nation in a given period.

(b)

To determine

Identify the impact on aggregate demand when increased fear of inflation.

Explanation of Solution

Inflation is a situation of continuous rise in the price level of goods and services in the economy. According to the consumers and investors, they would not receive any benefit from the consumption and investment during the period of inflation because of the higher-price level and higher-interest rate. Hence, the consumer and investors increase their spending and investment in the current period. Therefore, the fear of inflation will increase the current aggregate demand.

(c)

To determine

Identify the impact on the aggregate demand when the rapid growth of real income.

Explanation of Solution

The rapid growth of real income from abroad will influence the higher demand for exports. If the real income of Country C and Country W increases, they will demand more goods and services from abroad. Suppose Country U trades with Country C and Country W, and Country C and Country W demand more goods and services, then the export of Country U will increase. Since the net export is one of the components that influence the aggregate demand, an increase in the real income of Country C and Country W will demand more goods and services from Country U, and this will lead to an increase in the net export of Country U. Hence, an increase in export of Country U will increase the current aggregate demand of Country U.

Economics Concept Introduction

Net export: The net export is the difference between the total export and total import of a nation in a given period.

(d)

To determine

Identify the impact on the aggregate demand when there is a reduction in the real interest rate.

Explanation of Solution

The real interest rate is influenced by the savings and investment in the loanable funds market. Since the interest rate and investment have an inverse relationship, a fall in the real interest rate in the loanable funds market will increase the investment and consumer spending. Since the investment and consumer spending are the components of the aggregate demand, an increase in the investment and consumer spending will increase the current aggregate demand.  

(e)

To determine

Identify the impact on the aggregate demand due to a higher-price level.

Explanation of Solution

The higher-price level decreases the purchasing power of the money; hence, households spend more money to purchase the same quantity of goods with more money. Hence, the demand for money will increase, which causes an increase in the interest rate. Since the interest rate and investment have an inverse relationship, a higher interest will reduce the investment and consumer spending. Thus, a fall in the investment and consumer spending will reduce the aggregate demand. Therefore, a higher-price level reduces aggregate demand.