Question

ment 3. Determine how the following affects the slope of the out put demand curve, and explain your results: a) The MPC increases. (b) The intertemporal substitution effect of the real interest rate on current con- sumption increases (e) The demand for invest ument goods becomes less responsive to the real interest rate.

help with question 3 please

Answer 1

A) The marginal propensity to consume (MPC) is a proportion of aggregate raise in pay that a consumer spends on consumption of goods and services, as opposed to saving. And when MPC increases it will cause aggregate demand to be steeper. It is because MPC is a component of Keynesian macroeconomic theory and is calculated as the change in consumption divided by the change in income. So when MPC increases multiplier also increases as a result, small change in any exogenous variable will cause output to increase multiple times.

B) Intertemporal substitution effect is a measure of responsiveness of the growth rate of consumption to the real interest rate. It also implies that rise in the price level while other things remaining constant, decreases the value of money and raises the interest rate.

Therefore the Intertemporal substitution effect on consumption is one of the primary reasons why demand rises at lower interest rates. The larger the sensitivity of consumption spending to the real rate of interest, the flatter will be output demand curve.

C) When the demand for investment goods have less responsive to the real interest rate, the output demand curve will have lower slope i.e steeper. So for a given interest rate, investment demand will change by a lower amount. So that the output demand function will have higher slope (flatter).