Intermediate Macroeconomics ECON 15575084 Dr Andrew L H

Intermediate Macroeconomics ECON 15575084 Dr. Andrew L. H. Parkes “A Macroeconomic Understanding for use in Business” Day 6 Principles of Macroeconomics, Day 6 卜安吉

Why the AD Curve Slopes Downward P Y = C + I + G + NX Assume G fixed by gov’t policy. P 2 To understand the slope of AD, must determine how a change in P affects C, I, and NX. P 1 AD Y 2 Principles of Macroeconomics, Day 6 Y 1 Y 2

1. The Wealth Effect (P and C ) Suppose P rises: n The dollars people hold buy fewer g&s, so real wealth is lower. n People feel poorer, Result: C falls. Principles of Macroeconomics, Day 6 3

2. The Interest-Rate Effect (P and I ) Suppose P rises. n Buying g&s requires more dollars. n To get these dollars, people sell bonds or other assets. n This drives up interest rates. Result: I falls. (Recall, I depends negatively on interest rates. ) Principles of Macroeconomics, Day 6 4

3. The Exchange-Rate Effect (P and NX ) Suppose P rises: n U. S. interest rates rise (the interest-rate effect). n Foreign investors desire more U. S. bonds. n Higher demand for $ in foreign exchange market. n U. S. exchange rate appreciates. n U. S. exports more expensive to people abroad, imports cheaper to U. S. residents. Result: NX falls. Principles of Macroeconomics, Day 6 5 5

The Slope of the AD Curve: Summary An increase in P P reduces the quantity of g&s demanded P 2 because: • the wealth effect (C falls) • the interest-rate effect (I falls) • the exchangerate effect (NX falls) P 1 AD Y 2 Principles of Macroeconomics, Day 6 Y 1 Y 6

Why the AD Curve Might Shift Any event that changes P C, I, G, or NX – except a change in P – will shift the AD curve. P 1 Example: A stock market boom makes households feel wealthier, C rises, the AD curve shifts right. AD 1 Y 1 Principles of Macroeconomics, Day 6 Y 2 AD 2 Y 7

Why the AD Curve Might Shift n Changes in C – Stock market boom/crash – Preferences re: consumption/saving tradeoff – Tax hikes/cuts n Changes in I – Firms buy new computers, equipment, factories – Expectations, optimism/pessimism – Interest rates, monetary policy – Investment Tax Credit or other tax incentives Principles of Macroeconomics, Day 6 8

Why the AD Curve Might Shift n Changes in G – Federal spending, e. g. defense – State & local spending, e. g. roads, schools n Changes in NX – Booms/recessions in countries that buy our exports. – Appreciation/depreciation resulting from international speculation in foreign exchange market Principles of Macroeconomics, Day 6 9

A C T I V E L E A R N I N G 1: Exercise What happens to the AD curve in each of the following scenarios? A. A ten-year-old investment tax credit expires. B. The U. S. exchange rate falls. C. A fall in prices increases the real value of consumers’ wealth. D. State governments replace their sales taxes with new taxes on interest, dividends, and capital gains. Principles of Macroeconomics, Day 6 10 10

A C T I V E L E A R N I N G 1: Answers A. A ten-year-old investment tax credit expires. I falls, AD curve shifts left. B. The U. S. exchange rate falls. NX rises, AD curve shifts right. C. A fall in prices increases the real value of consumers’ wealth. Move down along AD curve (wealtheffect). Principles of Macroeconomics, Day 6 11 11