Question

Suppose that exports become more sensitive to changes in the price level in the United States. That is, when the price level in the United States rises, exports decline by more than they previously did. Will this change make the aggregate demand curve steeper or less steep? Briefly explain.

Short answer

The change would make the aggregate demand curve steeper.

Step-by-step solution

Understand the Relationship

First comprehend the relationship indicated in the question which means, if the price level rises in the United States, more exports decrease. This relationship tells us that exports are negatively sensitive to the price level-- an increase in the price level results in a decrease in exports.

Understand the effect on aggregate demand

Exports are one of the components of aggregate demand (AD). Therefore, if exports decrease more than they did previously for a given increase in the price level, that means that the overall aggregate demand decreases by more than before.

Determine the curve steepness

The aggregate demand curve is downward sloping indicating the inverse relationship between the price level and the quantity of output demanded. Therefore, if a rise in the price level results in a larger decline in aggregate demand (due to a decline in exports), the aggregate demand curve will become steeper than before.

Key concepts

Price Level Sensitivity

Understanding how the price level affects aggregate demand is crucial for analyzing changes in the economy. Price level sensitivity refers to how responsive exports and other components of aggregate demand are to changes in the general price level of goods and services. Imagine a seesaw, where one side represents the price level and the other side represents exports; as the price level goes up, exports are pushed down, indicating negative sensitivity.

In a scenario where this sensitivity increases, when prices in the United States rise, domestic products become more expensive for foreign buyers, and thus less attractive compared to alternative options. This causes exports to decline more for each increase in price level than they would have with lower sensitivity. It's similar to turning up the volume on your response to temperature – if you shiver more intensely with each degree drop, your 'sensitivity' has gone up.

Exports and Aggregate Demand

Impact of Exports on Aggregate Demand

Exports play a vital role in a country's economy, feeding into aggregate demand (AD), which is the total demand for final goods and services at a given time and price level. They are like the blood pumping into the heart of the economy – when they increase, they invigorate the market, contributing positively to AD. On the flip side, increased price sensitivity of exports can weaken AD.

When the U.S. dollar is strong, or prices in the U.S. go up, you can think of exports as a plane trying to take off in a heavy headwind – they struggle to rise. This headwind leads to a decrease in exports, which means that foreign injection of funds into the U.S. economy is reduced, subsequently depressing aggregate demand.

Steepness of Aggregate Demand Curve

The steepness of the aggregate demand curve tells a story about the economy’s reaction to changing price levels. If the curve is less steep, it shows that changes in price levels only result in modest changes in the quantity of output demanded.

Consider a steep hill versus a gently sloping hill: on the steep hill (a steeper AD curve), a small increase in price level may cause a sharp decline in demand. Conversely, on the gentler slope (a less steep AD curve), demand stays relatively stable despite changes in price levels. Increased sensitivity of exports to price levels, where exports decrease sharply with price hikes, will tilt the economy's 'hill' more steeply because now aggregate demand reacts more dramatically to the same changes in price, drawing a steeper aggregate demand curve.