Question

Suppose that the aggregate expenditure curve for an economy can be expressed algebraically as AE = 3,000 – 2,000r, where AE is aggregate expenditures and r is the real interest rate expressed as a decimal. If the level of potential output in this economy is 2,825, what is the long-run real interest rate?

Instructions: Enter your response as a percent rounded to one decimal place.

The long-run real interest rate: ____ %

Answer 1

-->  Aggregate expenditure is the total amount spent for the economy's output by all households, firms, foreigners, and the government. Prices are determined by the equilibrium between aggregate demand and aggregate supply, but aggregate expenditure is the amount actually spent, revealing actual demand at current prices and aggregate supply.

--> If the supply of money grows only as fast as the economy, then there will be a long-run real interest rate that equates aggregate expenditure with the potential output quantity.

Hence equating Aggregate Expenditure and Potential Output Quantity,

Given Potential output quantity is 2825 and Aggregate Expenditure is 300-2000R.

Equating both, we will get

AE = Potential Output Quantity

Given AE is 2825, Hence now

2825 = 3000 - 2000R.

2000R = 3000-2825

2000R = 175

Therefore R = 175/2000*100 = 8.75%

Hence the Long run real Interest rate is 8.8% ( as percent rounded to one decimal place).