/*! This file is auto-generated */ .wp-block-button__link{color:#fff;background-color:#32373c;border-radius:9999px;box-shadow:none;text-decoration:none;padding:calc(.667em + 2px) calc(1.333em + 2px);font-size:1.125em}.wp-block-file__button{background:#32373c;color:#fff;text-decoration:none} Q5. Why does a reduction in aggregat... [FREE SOLUTION] | 91影视

91影视

Log out

Learning Materials

Features

Discover

Chapter 12: Q5. (page 258)

Why does a reduction in aggregate demand in the actual economy reduce real output, rather than the price level? Why might a full-strength multiplier apply to a decrease in aggregate demand?

Short Answer

Expert verified

The reduction in aggregate demand in the actual economy reduces real output rather than the price level because the prices are sticky.

A full-strength multiplier applies to a decrease in aggregate demand because prices are not flexible.

Step by step solution

01

Sticky price

The price is sticky in the short run, as it takes time for the economy to absorb the information and then act.A reduction in aggregate demand only reduces the output level but not the prices as the prices are inflexible, i.e., sticky prices.

Suppose it is assumed that prices are inflexible and the aggregate supply curve is horizontal, then a decrease in aggregate demand will not change the price but will reduce the output. The prices do not fall because of several reasons like wage contracts, minimum wage laws, employee morale, fear of price wars, and the 鈥渕enu cost鈥� notion.

02

Multiplier effect on aggregate demand

When there is no price movement or change, the multiplier effect could act to its full strength on the aggregate demand. Suppose the prices are flexible, then with the change in spending, i.e., reduction in government spending, will reduce the prices. Thus, some individuals will spend more in the economy, diminishing the multiplier effect.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Over 30 million students worldwide already upgrade their learning with 91影视!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

Suppose that the table presented below shows an economy鈥檚 relationship between real output and the inputs needed to produce that output:

Input QuantityReal GDP
150.0\(400
112.5300
75.0200

  1. What is productivity in this economy?

  2. What is the per-unit cost of production if the price of each input unit is \)2?

  3. Assume that the input price increases from \(2 to \)3 with no accompanying change in productivity. What is the new per-unit cost of production? In what direction would the $1 increase in input price push the economy鈥檚 aggregate supply curve? What effect would this shift of aggregate supply have on the price level and the level of real output?

  4. Suppose that the increase in input price does not occur but, instead, that productivity increases by 100 percent. What would be the new per-unit cost of production? What effect would this change in per-unit production cost have on the economy鈥檚 aggregate supply curve? What effect would this shift of aggregate supply have on the price level and the level of real output?

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鈥檚 multiplier is 4. If household wealth falls by 5 percent because of declining house values, and the real interest rate falls by 2 percentage points, in what direction and by how much will the aggregate demand curve initially shift at each price level? In what direction and by how much will it eventually shift?

What effects would each of the following have on aggregate demand or aggregate supply, other things equal? In each case, use a diagram to show the expected effects on the equilibrium price level and the level of real output, assuming that the price level is flexible both upward and downward.

  1. A widespread fear by consumers of an impending economic depression.

  2. A new national tax on producers based on the value added between the costs of the inputs and the revenue received from their output.

  3. A reduction in interest rates.

  4. A major increase in spending for health care by the federal government.

  5. The general expectation of coming rapid inflation.

  6. The complete disintegration of OPEC, causing oil prices to fall by one-half.

  7. A 10 percent across-the-board reduction in personal income tax rates.

  8. A sizable increase in labor productivity (with no change in nominal wages).

  9. A 12 percent increase in nominal wages (with no change in productivity).

  10. An increase in exports that exceeds an increase in imports (not due to tariffs).

Which of the following will shift the aggregate supply curve to the right?

  1. A new networking technology increases productivity all over the economy.

  2. The price of oil rises substantially.

  3. Business taxes fall.

  4. The government passes a law doubling all manufacturing wages.

Distinguish between "real-balances effect" and "wealth effect," as the terms are used in this chapter. How does each relate to the aggregate demand curve?
See all solutions

Recommended explanations on Economics Textbooks

Taxation Economics

Read Explanation
View all explanations

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.