Question

If prices are sticky and the number of dollars of gross investment unexpectedly increases, the _____ curve will shift _____. a. \(A D ;\) right. b. AD; left. c. AS; right. d. AS; left.

Short answer

The correct answer is (a) AD; right.

Step-by-step solution

Identify the Components

First, identify the different components involved in the question. The key terms here are 'prices are sticky,' 'number of dollars of gross investment,' and 'curve will shift.' Also, recognize the choices offered: AD, AS, and directions (right or left).

Understand Sticky Prices

'Sticky prices' refer to the situation where prices of goods and services do not adjust immediately to changes in economic conditions. This is typically related to changes in aggregate demand (AD) rather than aggregate supply (AS), because AS is more about actual production capacities and costs, which aren't directly related to 'sticky' price effects.

Determine Effect of Increased Investment

An unexpected increase in gross investment means firms are spending more on capital goods, which usually leads to an increase in economic activity. In terms of output, this boosts demand for goods and services, shifting the aggregate demand (AD) curve.

Identify the Direction of the Shift

Since gross investment generally stimulates overall economic activity, demand for goods and services increases. This results in a rightward shift of the AD curve, as more demand equates to a higher level of output demanded.

Confirm the Correct Answer

From the analysis, with sticky prices and an unexpected increase in gross investment, the Aggregate Demand (AD) curve will shift to the right. Hence, the correct choice is (a) AD; right.

Key concepts

Aggregate Demand

Aggregate demand (AD) is a fundamental concept in macroeconomics that represents the total demand for goods and services within an economy at a given time and price level. It combines consumption by households, investment by businesses, government spending, and net exports, which is exports minus imports.

To visualize this concept, imagine a snapshot of an economy and all the different sectors—households, businesses, and government—all deciding on how much to spend. This spending influences the amount of goods and services produced, hence affecting the aggregate demand.

When economists talk about shifts in the aggregate demand curve, they refer to changes in the overall demand for an economy's goods and services. These shifts could be caused by various factors, such as:

• Changes in consumer confidence, which affect household spending
• Fluctuations in business investment
• Variations in government policy, such as tax adjustments
• Alterations in foreign trade dynamics

Understanding shifts in the AD curve is essential for analyzing economic performance. An increase or rightward shift in AD indicates economic growth, rising output, and often higher employment. Conversely, a decrease or leftward shift signifies economic contraction.

Sticky Prices

Sticky prices refer to the resistance of prices to change, despite shifts in supply or demand. In simpler terms, when the costs of goods and services don't readily adjust in response to economic conditions, they are considered 'sticky.'

This concept is pivotal as it explains why markets don't always reach equilibrium quickly and why economies might experience cycles of booms and busts. Sticky prices can result from several factors, including:

• Long-term contracts which set prices for extended periods
• Menu costs or the expenses associated with changing prices
• Psychological factors influencing consumer perceptions of price fairness

In cases where prices are sticky, changes in demand can lead to fluctuations in output rather than prices. For instance, if investment increases unexpectedly, businesses might produce more to meet higher demand, while prices remain unchanged in the short term.

This stickiness in prices explains why the economy could take time to adjust to new conditions, affecting decisions at both micro and macroeconomic levels.

Gross Investment

Gross investment is the total capital expenditure within an economy, reflecting how much businesses spend on acquiring new capital goods like machinery, factories, and technology.

This concept is part of the broader investment category in macroeconomics and plays a crucial role in economic growth as it relates to the creation and enhancement of productive capacity. Gross investment is different from net investment, as gross investment includes depreciation; hence, it's the total investment before accounting for worn-out or obsolete capital.

When discussing gross investment, consider its impact on various economic aspects:

• It directly influences aggregate demand, as increased investment can boost demand for construction and manufacturing sectors.
• It is a significant determinant of future productive capacity, potentially leading to larger future output and economic growth.
• Unexpected increases in gross investment can spur economic activity, prompting a shift in the aggregate demand curve to the right.

Understanding gross investment helps economy watchers predict business cycles and assess the vitality of different sectors.