Question

Explain what happens to aggregate demand in each of the following cases: a. The interest rate rises. b. Wealth falls. c. The dollar depreciates relative to foreign currencies. d. Households expect lower prices in the future. e. Business taxes rise.

Short answer

a. Decreased Demand. b. Decreased Demand. c. Increased Demand. d. Decreased Demand. e. Decreased Demand.

Step-by-step solution

Understanding The Impacts

Look at each case one by one and understand what each of the changes implies for aggregate demand.

Explaining Case 1: Interest Rate Rises

A rise in interest rates increases the cost of borrowing and reduces disposable income, which would lead to a decrease in consumption and thus a decrease in aggregate demand.

Explaining Case 2: Wealth Falls

When wealth falls, individuals and businesses have less money to spend. This leads to a decrease in consumption and investment, reducing aggregate demand.

Explaining Case 3: The Dollar Depreciates Relative to Foreign Currencies

When the dollar depreciates relative to foreign currencies, exports become cheaper and imports become more expensive. This increases the demand for domestically produced goods and services, causing aggregate demand to increase.

Explaining Case 4: Households Expect Lower Prices in The Future

If households expect prices to be lower in the future, they may delay consumption, leading to a decrease in current aggregate demand.

Explaining Case 5: Business Taxes Rise

An increase in business taxes reduces after-tax profits, which in turn reduces the funds available for business investment. Lower investment leads to a decrease in aggregate demand.