Question

Suppose that consumer spending initially rises by $5 billion for every 1 percent rise in household wealth and that investment spending initially rises by $20 billion for every 1 percentage point fall in the real interest rate. Also assume that the economyâs multiplier is 3.
If household wealth falls by 5 percent because of declining house values, and the real interest rate falls by 2 percentage points, in what direction and by how much will the aggregate demand curve initially shift at each price level?

Answer 1

Answer: Aggregate Demand will shift by $25 billion dollars at each price level

Explanation:

1 % rise in Household wealth increases , Consumer Spending by $5 Billion. We can assume that when Household wealth Decreases by 1% consumer spending decreases by $5 billion dollars.

if Household Wealth Decreases by 5% aggregate demand will fall by $25 Billion (1% represents 5 Billion, so 5% will be $5 Billion x 5). Aggregate Demand Curve will initially shift by $25 billion at each price level when household wealth Falls by 5%