Question

Suppose that consumer spending initially rises by $5 billion for every 1 percent rise in household wealth and that investment spending Initially rises by $20 billion for every 1 percentage point fall in the real interest rate. Also assume that the economy's multiplier is 4 a. If household wealth falls by 4 percent because of declining house values, and the real interest rate falls by 3 percentage points, in what direction and by how much will the aggregate demand curve initially shift at each price level? Aggregate demand will shift by billion b In what direction and by how much will it eventually shift? Aggregate demand will shift by ballon

Answer 1

Consumer spending rises by $5 billion for every 1% increase in household spending. Investment spending initially rises by $20 billion for every 1% point fall in real interest rate.

a) If household wealth falls by 4%, consumer spending will fall by $20 billion. Additionally, 3% point fall in real interest rate will raie investment spending by $60 billion.

Aggregate demand will shift right by $40 billion ($60 billion - $20 billion)

b) As Multiplier is 4

Total aggregate demand will shift to its right by $40 billion * 4 = $160 billion.