Use The Aggregate Supply And Demand Model To Determine

Use The Aggregate Supply and Demand Model To Determine

Question 1 for Each Of The Following Events Use The Aggregate Supply and demand model to determine the short-run change in the economy's price level and real output. a. A stock market crash reduces households' wealth. b. OPEC succeeds in raising the price of crude oil, an important resource. c. A decrease in interest rates leads to an increase in the level of investment spending. Question 2 Suppose the government decides to reduce its spending on goods and services. a. What would be the short-run consequences of this decision on the equilibrium price level and real output? Use the AS-AD model to illustrate. b. What would be the long-run consequences of this decision on the equilibrium price level and real output? Use the AS-AD model to illustrate. Question 3 Use the table below, which shows consumption and investment spending as functions of disposable income for Nelsburgiaville, to answer the following questions. There is no government spending in the country, which also does not trade with the rest of the world. All figures are in millions of Nelsburgiavillian dollars (N$). planned DI C I a. What is the marginal propensity to consume in Nelsburgiaville? b. What is the marginal propensity to save in Nelsburgiaville? c. What is the equilibrium level of disposable income in the country? d. If income was $7000 million, explain the process by which the income of the country would change to the equilibrium level. e. If income is $7000 million, how much money are households saving? f. If income is $7000 million, how much money are firms spending on investment? Question 4 Economists observed the only five residents of a very small economy and estimated each one’s consumer spending at various levels of current disposable income. The accompanying table shows each resident’s consumer spending at three income levels. a) What is each resident’s consumption function? What is the marginal propensity to consume for each resident? b) What is the economy’s aggregate consumption function? What is the marginal propensity to consume for the economy? Question 5 The graph below shows the consumption function for Nelston, a country with no government and no trade with the rest of the world. All figures are in millions of Nelston dollars (N$). Use the information to calculate the following. a. What is the marginal propensity to consume in Nelston? b. What is the marginal propensity to save in Nelston? c. What is the equilibrium level of income in Nelston? d. If income is $2600, how much money are households saving? e. If income is $2600, how much money are firms spending on investment? f. What is the value of the simple spending multiplier? Question 6 The marginal propensity to save in Noslenia is 0.125. Use this fact to answer the following questions. a. What is the value of the marginal propensity to consume in Noslenia? b. What is the value of the simple spending multiplier in Noslenia? c. Suppose that firms, because of lower interest rates, decide to increase their investment spending by $700 million. By how much will this increase in investment spending increase equilibrium disposable income?

Paper For Above instruction

The queries presented involve the application of fundamental macroeconomic models, particularly the aggregate supply and demand (AS-AD) framework, to analyze various economic shocks and policy decisions. Understanding how different events influence equilibrium levels of output and price levels in the short and long run is central to macroeconomic analysis. The following discussion explores these scenarios systematically, integrating theoretical insights with empirical evidence.

Question 1: Short-Run Effects of Economic Events Using AS-AD Model

The aggregate supply and demand model serves as an essential tool in understanding the short-run effects of economic shocks. In the case of a stock market crash reducing household wealth (event a), consumer spending declines, leading to a leftward shift of the aggregate demand curve. Consequently, this results in a decrease in both the price level and real output, illustrating a contractionary demand shock. Similarly, an increase in oil prices by OPEC (event b) raises production costs, which shifts the short-run aggregate supply curve upward (or leftward), leading to an increase in the price level and a potential decrease in output, indicative of cost-push inflation. Lastly, a reduction in interest rates that stimulates investment (event c) shifts the aggregate demand curve rightward, raising both the price level and real output in the short run, reflecting expansionary monetary policy effects.

Question 2: Impact of Government Spending Reductions

When the government decreases its expenditure on goods and services, the immediate short-run effect is a leftward shift of the aggregate demand curve, translating into lower equilibrium output and a possible decline in the price level, assuming fixed short-run aggregate supply. Over the long run, however, this reduction can influence the economy's potential output and price level depending on the nature of the fiscal policy and related supply-side factors. If supply is unaffected, the long-run aggregate supply curve remains unchanged, and thus the long-run equilibrium features a lower output with potentially deflationary pressures. Conversely, if reduction in government spending dampens aggregate demand persistently, it might also influence long-term growth prospects by affecting investment in public goods and infrastructure, which are vital for productivity improvements.

Question 3: Consumption, Saving, and Investment Functions in Nelsburgiaville

Based on the given data, the marginal propensity to consume (MPC) can be calculated by dividing the change in consumption by the change in disposable income between data points. This reflects consumer behavior in response to income changes. The marginal propensity to save (MPS) complements MPC as it represents the portion of additional income households save. The equilibrium disposable income is determined at the point where planned consumption equals disposable income minus planned savings. As income increases to $7000 million, households and firms adjust their savings and investment respectively, contributing to the sustainable level of economic activity. These calculations exemplify the Keynesian consumption function, which critically influences aggregate demand and, consequently, overall economic stability.

Question 4: Resident Consumer Spending and Aggregate Consumption Function

The analysis of consumer spending by residents reveals individual consumption functions, which are typically linear relationships between current disposable income and consumer expenditure. Estimating each resident's consumption function involves calculating their marginal propensity to consume (MPC). The aggregate consumption function then aggregates individual functions, weighted by population. Variations among residents' MPCs affect the slope of the aggregate function, which in turn influences the economy's response to income changes. Understanding this relationship is crucial for policymakers seeking to stimulate or temper economic activity through fiscal measures.

Question 5: Consumption Function, Savings, and Investment in Nelston

Using Nelston's consumption function, the MPC is derived from the slope of the consumption-income relationship. The marginal propensity to save (MPS) is simply 1 minus MPC. The equilibrium income level occurs where planned consumption equals income, which can be solved algebraically. At this equilibrium, household savings are the residual of income not consumed. Firms' investment spending at this income level further sustains aggregate demand. The simple spending multiplier, calculated as 1 divided by MPS, indicates the total potential impact of change in autonomous expenditure on national income, emphasizing the potency of fiscal policy in stimulating economic activity.

Question 6: Marginal Propensity to Consume and Save in Noslenia

Given the marginal propensity to save (MPS) of 0.125 in Noslenia, the MPC is 0.875 (since MPC + MPS = 1). The simple spending multiplier is calculated as 1 divided by MPS, which would be 8, signifying that any autonomous change in spending will be magnified eightfold through the economy. For example, an increase in investment spending by $700 million would, through the multiplier effect, increase equilibrium disposable income by $5.6 billion (700 million x 8). This illustrates the profound influence of fiscal stimuli, especially in small open economies where the multiplier effect can significantly impact overall economic activity.

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