The extent to which investment responds to a change in interest rates is a crucial factor in how effective monetary policy is. That lowers bond prices, raises interest rates, and reduces investment and aggregate demand. When the Fed seeks to decrease aggregate demand, it sells bonds. A macroeconomic externality occurs when what happens at the macro level is different from and inferior to what happens at the micro level. That raises bond prices, reduces interest rates, and stimulates investment and aggregate demand as illustrated in Figure 14.6 “A Change in Investment and Aggregate Demand”. The expenditure multiplier is a Keynesian concept that asserts that a change in autonomous spending causes a more than proportionate change in real GDP. When the Fed seeks to increase aggregate demand, it purchases bonds. The relationship between investment and interest rates is one key to the effectiveness of monetary policy to the economy. Here, for example, the quantity of real GDP demanded at a price level of 1.0 rises from $8,000 billion per year at point C to $8,100 billion per year at point D.Ī reduction in investment would shift the aggregate demand curve to the left by an amount equal to the multiplier times the change in investment. The total quantity of real GDP demanded increases at each price level. With a multiplier of 2, the aggregate demand curve shifts to the right by $100 billion in Panel (b). The key element in this multiplier effect is how consumers respond to changes in their incomes. This could help America's economy "cool down" if the American economy has already surpassed its potential GDP, or cause the American economy to go into a recession if the American economy is already below its potential GDP.Figure 14.6 A Change in Investment and Aggregate DemandĪ reduction in the interest rate from 8% to 6% increases the level of investment by $50 billion per year in Panel (a). One is that changes in government spending or taxation are multiplied in their effect on the economy. Contraction in China's economy will result in American aggregate demand shifting to the left. This could lead to the US growing its real GDP if its current real GDP is below potential GDP, but if real GDP is above potential GDP, then inflation will result with little increase in real GDP. (Answer to question 2) Growth in China's economy will result in American aggregate demand shifting to the right. (Answer to question 1) Change in China's economy impacts the American economy by having some power to shift the US aggregate supply to the left or right. A decrease in exports will shift aggregate demand to the left. An increase in exports will shift the aggregate demand curve to the right. If China's economy contracts, it's demand for American exports will also contract.ģ. As China's economy grows, it's demand for American exports also grow. America is one of China's largest exporting partners.Ģ. Types of Legal Reserve Ratios So there are 2 types of Legal Reserve Ratios that are being taught in class 12 macroeconomics. Aggregate demand will shift to the right and may cause inflation if it goes beyond potential GDP."ġ. In terms of gross domestic product, the multiplier effect causes changes in total output to be greater than the change in spending that caused it. According to the text on this article: "Rapid growth by a major trading partner will increase demand for exports. AP Macro > Unit 3 3.2 Spending and Tax Multipliers 4 min read decemJ Jeanne Stansak Haseung Jun Multipliers Basic Vocabulary Multiplier effect The idea that an initial change in spending will set off a spending chain that is magnified in the economy.
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