Unit IV Questions

UnitIV Questions

Q1.How is an aggregate demand curve derived? What would cause theaggregate demand curve to shift to the right?

Inan economy, aggregate demand is the total demand for goods andservices. Therefore, an aggregate demand curve is derived from thequality of goods and services and their prices. It graphicallyrepresents prices versus gross domestic produce (GDP) at differentprice level (McEachern,2012).The aggregate demand curve shifts to the right when total good andservices bought at the same price has increased. This phenomenon isdue to several factors such as interest rates, change in investordemand, and change in government spending, among others. Forinstances, if the government choose to increase spending with the aimto boost economy then, the aggregate demand curve will automaticallyshift to the right. In addition, decrease of interest rate would alsomake the aggregate demand curve to shift to the right.

Q2.For each of the following, explain whether its shits the short-runaggregate supply curve, the long-run aggregate supply curve, or theaggregate demand curve

  1. Households decide to save a smaller share of their disposable income

Thischanges the aggregate demand by increasing it. This is because thereis more money used to buy goods and services. In addition, householdsget money that they can either save or spend. In essence, when theysave less, they spend more hence, the aggregate demand increases.

  1. There is an 8-week strike in the steel industry

Thischanges the short-run aggregate supply curve. A strike in steelindustry means that in a short term, less steel is produced. As aresult, it will reduce aggregate supply for the economy.

  1. A drought in the Midwest causes poor wheat harvest.

Thischanges the short-run aggregate supply curve. Poor wheat harvest islikely to reduce the supply of wheat. However, this will not reduceeconomy capacity in the long term.

  1. The labour force participation rate increases

Thisincreases both the short-run and long-run aggregate supply curves.Increase in labour forces means more goods are produced hence, theaggregate supply increases.

Q3.Explain what would cause the government purchases function toincrease. Will a change in social security spending affect governmentpurchases?

Governmentpurchases function increases only under special circumstances(McEachern,2012).For instance, in case of a terrorist attack that can cause thegovernment to increase spending on security matters. The governmentpurchases in regardless of income in the economy or the tax revenuethey correct. It is always willing to borrow for it to spend makingits purchases independent of tax revenues and income. A change insocial security spending do not affects the government purchases.Social security payments are not payment for work done, but transferpayments. However, transfer payments are not government purchases.

Q4.Suppose MPC is 0.8 initially. Households then change their behavioursso that the MPC falls to 0.75. What happens to aggregateexpenditures? Why?

Ifthe MPC decreases from 0.8 to 0.75, it means that the aggregateexpenditure will also decrease. This is due to the fact that peoplewill spend less on consumption and save more of their money.According to McEachern(2012),if the marginal propensity to consume (MPC) is high, people spendmore on the money they earn within marginal income. For instance, ifthe MPC is 0.8, people will spend 80% from marginal income they make.If MPC drops to 0.75, the spending will also decrease. If peopleconsume less and save more, the consumption rate decreases. As aresult, there is less economic activity. Therefore, an increase ofMPC leads to a decrease in consumption rate hence, a decrease inaggregate expenditure.

Q5.What is a consumption function? Describethe graph of a consumption function and explain its shape. If totalspending is consumption plus investment spending, how does anincrease in the interest rate affect total spending?&nbsp

Theconsumption function is the connection between disposable income andconsumption rate of a household sector of an economy (McEachern,2012).The graph of a consumption function derived from a linear equationhence, linear graph with a straight line. It is expressed in aslope-intercept form as

Autonomousconsumption+MPC*disposable income= consumption

Therefore,autonomous consumption and MPC affects consumption.

Anincrease in interest rate decreases total spending. Increase ofinterest rates means that people will reduce their spending to stayaway from high interest payments. At low interest rates, people willincrease their spending because they pay relatively low interest.


McEachern,W. A. (2012). ECON Macro 3 (3rd ed.). Mason, OH: South-Western.