The aggregate demand curve represents the total quantity of goods and services demanded





Econ – 4

Question 1

The aggregate demand curve represents the total quantity of goods and services demanded in the economy at different price levels in a given period. The following graph illustrates the demand curve.

When the government cuts government spending (G) and taxes (T) by the same amount, the consumers will have more money to spend. Their purchasing power will rise or the buyers will become wealthier, there will be an inverse relationship between the price level and the real GDP which will be reflected in the demand curve sloping downwards, or the demand curve will shift to the left. Assuming the demand curve equation is given by

AD = c + I + G + (X-M)

Where C is consumer spending, I is investment spending by companies on capital goods, G is government spending on publicly provided goods and services, Y is exports of goods and service, and M is imports of goods and services.

Question 2

When using the aggregate demand/aggregate supply model, the economy will self adjust itself in the following manner to eliminate a recessionary gap.

This is the process by which the aggregate market eliminates a recessionary gap which is created by short term equilibrium in employment by wage decreases, and other resource prices. The self adjusting mechanism will be influenced by short term market imbalances that will settle with long term price flexibility.

This graph illustrates how the economy will self adjust itself.

Adjustment is seen as shifts in the short term aggregate supply curve with changes in wages and other recourses, the recessionary gap will close with lower wages and increase in short term aggregate supply curve.

Eliminating an expansionary gap is an economy operating under full employment. Demand of goods and services also rises, and consumer goods prices increases Inflation rises

Question 3

Using the aggregate demand/inflation adjustment model, the following will happen to output (Y) and inflation (π) in response to the following events either in the short run or long run.

An economy boom in the US that causes an increased demand for Canadian goods.

The interest rates are cut which is the expansionary monetary policy, thus the aggregate demand shifts upwards due to rises in investment and consumption. There would be a corresponding rise in and the price level. GDP In the US, there will be an economic boom or a rise in real output, the wage rises in Canada will cause a shift of the aggregate supply making the US to lose some of the gains made from the expansionary monetary policy.

An equivalent decrease in government spending and taxes.

It would result to an increase in expenditure and a corresponding increase in de3mand. The demand curve will shift to the right, and real GDP will grow above potential. The inflation adjustment line would shift upwards, and an increase in inflation

A significant increase in consumer confidence will cause the aggregate demand curve to shift, as there will be increases in output. regardless of the inflation in the economy.

A significant increase in benefits paid to workers, there would be shifts in the inflation adjusted line, the rate of inflation will start to fall, and consumer goods will be more attractive to buyers to purchase.

The retirement of a significant portion of the workforce; there will be need to expand production without increasing prices, machines will work over time

The bank of Canada tightens the monetary policy: Thee Federal Reserve will have to control inflation to avoid a recession, by using contradictory monetary policy to slow economic growth. The Federal Reserve can slow economic growth by tightening the money supply to reduce liquidity in the financial system

Firms become less optimistic about future demand for their goods

Firms cut investments plans for the future, uncommitted spending, industry costs will move down, and organizational changes to improve their future cost structure.

A significant decrease in the value of the stock market.

Executives will have the incentive and opportunity to manage the timing of inside information to the market. They will benefit from stock price decreases before the grant date, and create an opportunity for insiders to benefit by raking in profits, by manipulating the timing of the information. People will be able to raise the prices of the stocks, assuming that it will rise in the future (Alaimo, &, Humberto, 123).

An increase in Canadian demand for imported food

Canada may face a food crisis, increase of food prices of food in Canada, while agricultural trade surplus will decline in the US. There would be an economic boom in the US

The government introduces a new subsidy to reduce the price of gasoline

Will affect government accounts, and lead to worsening of the fiscal balance because of increased government expenditure, lesser revenues, and net current transfers. It will also affect balance of payments, since price changes in exports and imports subject to the subsidy influence trade flows through price and real exchange rate elasticities. Subsidies will affect the long run growth potential of the economy. There would be a significant distortive effect in the investment of physical plants that could be more energy intensive. The constrained budget situation effects will come from a range of adverse secondary macro economic effects

Works cited

Alaimo, V, &, Humberto, L. Oil Intensities and Oil Prices: Evidence for Latin America.”Policy Research Working Paper 4640, World Bank, Washington, DC. (2008) “