# Quiz 12: Aggregate Demand and Aggregate Supply

_{1}a and 1b in the Appendix. Assume that Q 1 iS

_{3}00, Q 2 iS

_{2}00, Q 3 iS

_{1}00, P

_{3}iS

_{1}20, P

_{2}iS

_{1}00, and P

_{1}is 80. If the price level increases from P

_{1}to P

_{3}in graph (b), in what direction and by how much will real GDP change? If the slopes of the AE lines in FigurE

_{1}a are.8 and equal to the MPC, in what direction will the aggregate expenditures schedule in FigurE

_{1}a need to shift to produce the previously determined change in real GDP? What is the size of the multiplier in this example?

a decrease of $200; a decrease of $40; 5.
Feedback: Consider the following example. Refer to FigurE_{1}a and 1b in the Appendix. Assume that Q 1 iS_{3}00, Q 2 iS_{2}00, Q 3 iS_{1}00, P_{3} iS_{1}20, P_{2} iS_{1}00, and P_{1} is 80. If the price level increases from P_{1} to P_{3} in graph (b), in what direction and by how much will real GDP change If the slopes of the AE lines in graph (a) are.8 and equal to the MPC, in what direction will the aggregate expenditures schedule in graph (a) need to shift to produce the previously determined change in real GDP What is the size of the multiplier in this example
If the price level increases from P_{1} to P_{3} in graph (b), in what direction and by how much will real GDP change
Real GDP will fall (movement along the AD schedule and a shift downward of the AE schedule). The decrease in real GDP will bE_{2}00 (Q 1 - Q 3 = 300 - 100 = 200).
If the slopes of the AE lines in graph (a) are.8 and equal to the MPC, in what direction will the aggregate expenditures schedule in graph (a) need to shift to produce the previously determined change in real GDP What is the size of the multiplier in this example
The first step is to determine the multiplier for this problem. Given the MPC is 0.8 the multiplier is 5 (= 1/(1-MPC) = 1/(1-0.8) = 1/0.2 = 5).
Since the multiplier is 5, we can find by how much the aggregate expenditure curve must change.
Real GDP decreases, which implies the AE schedule must fall (to AE_{3} at P_{3} ).
The AE curve must fall by $40 since the total decrease in output is $200.
To see this, note that a decrease in AE by $40 with a multiplier of 5 is $200 (= 5 x $40).
Change in real GDP = multiplier x change in AE
Rearranging this equation,
Change in AE = change in real GDP/multiplier
Using the values above, the change in AE equals -$200/5 = -$40, or we can express the negative as a decrease of $40 as above.

A change in the price level does not shift the aggregate demand curve. It simply represents a movement along the curve, because there is an inverse relationship between the price level and aggregate quantity demanded.
However, a change in the price level will shift the aggregate expenditures curve, which responds to the wealth, interest-rate, and foreign purchases effects occurring with a change in price level. When the price level declines, aggregate expenditures will rise, and when the price level rises, aggregate expenditures will fall. The aggregate expenditures model assumes a constant price level, so it is expressed in "real" terms. Appendix FigureS_{1} and 2 graphically illustrates the relationship between the two models.

Aggregate Demand Aggregate demand refers to the quantity of all the products and services that is demand within the economy during the period of a financial year. It includes the amounts of products and services that the population is willing purchase at all price levels. Real Interest Rate The real interest rate is the interest rate that an investor gets after subtracting the rate of inflation. According to the Fisher equation, Real interest rate can be calculated by subtracting the inflation rate with the nominal interest rate. Initial Change in aggregate demand: Fall in the household wealth: Due to a fall in the household wealth by 5%, the consumer spending will decline by $5 billion per 1 percent. Therefore, the decline consumer spending due to declining house values is; Thus, the consumption part of aggregate demand declines by $250 million. Fall in real interest rate: On the other hand, interest rates declines by 2%, furthermore, it is given that the investment spending increases by $20 billion for every percentage decline in the real interest rate. Therefore, the increase in investment spending due to fall in real interest rates is; Furthermore, the net effect of an increase in investment spending and a decrease in consumer spending on the aggregate demand is shown below; Thus, the aggregate demand curve shifts towards right by $150 million initially; however, due to multiplier effect the aggregate demand curve shifts further, the shift in aggregate demand due to multiplier effect is shown below; Thus, due to a decline in hose values and a decline in real interest rates the aggregate demand curve initially shifts rightward by at each price level; and eventually, rightward by due to multiplier effect.

_{2}in the Appendix and assume that Q 1 is $400 and Q 2 is $500, the price level is stuck at P

_{1}, and the slopes of the AE lines in FigurE

_{2}a are.75 and equal to the MPC. In what direction and by how much does the aggregate expenditures schedule in FigurE

_{2}a need to shift to move the aggregate demand curve in FigurE

_{2}b from AD1 to AD2? What is the multiplier in this example? Given the multiplier, what must be the distance between AD1 and the broken line to its right at P

_{1}?

_{1}50, will quantity demanded equal, exceed, or fall short of quantity supplied? By what amount? If the price level iS

_{2}50, will quantity demanded equal, exceed, or fall short of quantity supplied? By what amount? c. Suppose that buyers desire to purchase $200 billion of extra real output at each price level. Sketch in the new aggregate demand curve as AD1. What is the new equilibrium price level and level of real output?

_{2}. Suppose that the present equilibrium price level and level of real GDP arE

_{1}00 and $225, and that data set B represents the relevant aggregate supply schedule for the economy.

_{1}990s and early 2000s and (b) how a strong negative wealth effect from, say, a precipitous drop in house prices could cause a recession even though productivity is surging.

_{2}months following the September 11, 2001 attacks on the United States, consumption also declined. Use AD-AS analysis to show the two impacts on real GDP.