AD Model What Is the Effect on AD? 5 scenarios graphically illustrated

Question

Topic: macroeconomics, AD-AS Model

What Is the Effect on AD?

Determine the effect on the short-run aggregate demand (AD) curve for each of the following scenarios and Please Graphically illustrate answer for each # 1-5.

1. A decrease in consumer wealth is due to a plunge in stock prices.
2. Households and businesses have more optimistic expectations regarding future economic performance
3. There are higher levels of investment spending by businesses.
4. The government cuts taxes for households and businesses. 
5. The Fed decreases the money supply.

 

Answer 1

Here's a breakdown of how each scenario affects the Aggregate Demand (AD) curve:

1. A decrease in consumer wealth due to a plunge in stock prices: This will decrease AD. People feel poorer, so they spend less. The AD curve shifts to the left.

2. Households and businesses have more optimistic expectations regarding future economic performance: This will increase AD. If people and businesses are optimistic, they will spend and invest more. The AD curve shifts to the right.

3. There are higher levels of investment spending by businesses: This will increase AD. Increased investment is a component of AD. The AD curve shifts to the right.

4. The government cuts taxes for households and businesses: This will increase AD. Lower taxes mean more disposable income, leading to increased spending. The AD curve shifts to the right.

5. The Fed decreases the money supply: This will decrease AD. A smaller money supply leads to higher interest rates, which discourages borrowing and spending. The AD curve shifts to the left.