Question

1.Describe the impact of rising interest rates on consumer spending.

2. When the economy is operating at full employment, why is an increase in aggregate demand not helpful to the economy?

3. When the economy is hit with a supply shock, such as oil prices rising from $25 a barrel to $75 a barrel, why is this doubly disruptive and harmful to the economy?

4. Explain why the aggregate supply curve is positively sloped during the short run and vertical in the long run.

5. List some examples of factors that will shift the aggregate demand curve.

6. List some examples of factors that will shift the long-run aggregate supply curve.

Answer 1

1.

Rising interest rate increases the cost of borrowings. It makes investment and consumption spending to decrease as consumers are discouraged to spend. So, consumer spending decreases with rising interest rates.

2.

At the level of full employment output, if AD increases further, then unemployment decreases to be less than the natural rate of unemployment and demand pull inflation sets in the economy. It makes  SRAS to shift to the left to offset the rise in cost of labor. As a result, price level increases, but real output comes back to the potential output level. It makes people to pay more at higher prices, but real output does not change. It is harmful to the economy.

3.

When price rises, then it creates negative supply shock.  It makes SRAS to shift to the left. It causes, increase in price and reduce in the output level. The first disruption is that it causes prices to rise and AD to decrease. The second disruption is the increase in unemployment that further decreases the AD and economy suffers due to the negative supply shock.

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