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?

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 3.

a. 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? b. In what direction and by how much will it eventually shift?

The solution of this question is given below in the explanation section

Explanation:

a)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?

Solution:

Household wealth falls by 5 percent, so the consumer spending will decline by $5 billion per 1%.

Therefore, we first calculate the declining in consumption of household.

Decline in consumption=5 billion x 5% = $250 million

So,consumption in Aggregate demand falls by $250 million .

Now, we will calculate the declineing in interest rate:

Decline in Interest rate = 2% and investment speding increases by $20 billion for every 1%

Therefore, increase in investment spending = $20 billion x 2% = $400 million

Now, we will calculate the change in aggregate demand (AD)

Change in AD = change in consumption + change in investment

= 400 - 250 million = $150 million

Initially, aggregate demand curve shifts to the right by $150 million but the shift will be bigger due to the multiplier effect.

b) Given multiplier = 3

So, Real GDP changes by $150 million x 3 = $450 million

So,initially Aggregate demand curve shift to the right by $150 million but eventually shifts to the right by $450 million due to the multiplier.

Parrain Parrain · Answer 2 · 2022-03-29T15:25:14+02:00

Based on the fall in household wealth and the fall in real interest rates, the aggregate demand curve would initially shift rightward by $15 billion.

What would be the change in aggregate demand?

Household wealth fell by 5% which means that the change in aggregate demand is:

= 5 x 25 billion

= -$25 billion

Real interest rates fell by 2% so the change in aggregate demand is:

= 2 x 20

= $40 billion

The net change is:

= 40 billion - 25 billion

= $15 billion

An increase in aggregate demand causes a rightward movement so this is a rightward movement of $15 billion.

The first part of the question is:

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.

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