Economics Notes: Small and Open Economies, Growth, Aggregate Supply and Demand

On the other hand, the reasons for increases of consumer expenditure and investment levels as mentioned above are only all valid if ceteris paribus is assumed. In reality, both factors of aggregate demand can be affected by multiple other external factors for example, consumer expenditure can be affected by the marginal prosperity to consume amongst consumers and therefore if this is very low then a cut in interest will see a minimal change in consumption and investment levels. In terms of consumers and firms if a large cut were to occur it would have a far superior effect in comparison to a small cut which could potentially have no impact. As well as this it can also be affected by the Income Elasticity ofDemand this means the responsiveness of the demand for a good to a change in

Three reasons the aggregate-demand curve slopes downward are the wealth effect, the interest-rate effect, and the exchange rate effect. The wealth effect explains that when the price level decreases, each consumer is wealthier because the real value of his or her dollar has increased. Wealthier consumers spend more, increasing the demand for consumption goods and services. Conversely, if the price level rises, the real value of the dollar will decrease, effectively making consumers poorer. Poorer consumers will spend less on consumption, decreasing the demand for goods and services.

National fiscal policies are influenced by the Federal Reserve, including the increase or decrease of interest rates. This affects mortgage rates and prices. When interest rates fall the demand for housing tends to rise, conversely when interest rates rise the housing market is adversely affected. There are several federal government divisions active in the role of reducing interest rates to stimulate the housing market including the Federal Housing Finance Agency, HUD, FEMA and the central bank (Weil, 2008).

The three reasons a lower price level leads to an increase of goods and services are an increase in the purchasing power of money, reduction in the demand for money and lower real interest rate and the making domestic produced goods less expensive (Gwartney, Stroup, Sobel & Macpherson,, 2013, p.

When dealing with interest rates and inflation the standard equation that is used is Fisher equation. What the fisher equation explains is that the real interest rate and expected inflation equals to the nominal interest rate (it = rt + Etπt+1) This means that a rise in expected inflation causes lenders to raise their nominal interest rates as there would be a decrease in the value of their loans due to purchasing power of repayments being lower and this causes the decline in investment as borrowing costs rise.

However, lower import costs offset negative consequences of export decline, and the total effect of the currency appreciation becomes muted.

A: Investment spending depends on interest rates due to opportunity cost and risk. For example, when interest rates rise, the opportunity cost of your investment also increases. When interest rates are higher investors are willing to pay less for payment in the future. Which in turn leads to a lower rate of investment. The opposite can be said for falls in interest rates that are met will lower opportunity costs.

Ostensibly, an increase in revenue of exports would decrease the CAD, while an increase in payments for foreign goods and services would raise the CAD (Bernanke et. al).

In blue we have the interest rate in the loanable funds market, and in red, the interest rate in the money market. If the real interest rate is above the nominal interest rate, either the investment exceeds the desired savings or the supply of money exceeds the demand of money. Shifting the saving curve to the right, and the demand of money to the right, will bring the interest rate in both markets to be the same.

If the rate of interest began to rise above the equilibrium level there would be an excess supply of money. This excess supply could be used to invest and buy bonds as people have more money balances than they need. This will in turn push up bond prices and interest rates will begin to fall due to the inverse relationship. Low interest rates encourage people to spend more. The opportunity cost of spending is saving, if interest rates are lower, people will receive less interest on their savings so there will now be a lower opportunity cost of spending. This spending will increase demand to the point where it is back at equilibrium.

Figure 2 demonstrate how any change in one of the other determinants causes demand to rise or to fall by shifting the whole curve to the right or the left. Other factors that determinates of demand

An easy way to understand the economist's view of saving—and its importance for economic growth—is to consider an economy in which there is a single commodity, say, corn. The amount of corn on hand at any point in time can either be consumed (literally gobbled up) or saved. Any corn that is saved is immediately planted (invested), yielding more corn in the future. Hence, saving adds to the stock of corn in the ground, or in economic jargon, the stock of capital. The greater the stock of capital, the greater the amount of future corn, which can, in turn, either be consumed or saved.

| Critics of spending hikes argue that tax cuts can expand both aggregate demand and aggregate supply and that hasty increases in government spending may lead to wasteful public projects.Tax cuts increase aggregate demand by increasing household’s disposable income, as

In the long-run, because of the structure of the production function, the capital is subject to diminishing returns, that is to say, “as the stock of capital rises the extra output produced from an additional unit per capita falls”. That means the curve of the productivity becomes flatter as the amount of capital increases (Mankiw and Taylor 2011, pp. 536).

In both the views the rate of Interest plays an important role in the determination of savings. The chemical economists commonly hold that the rate of saving is the direct function of the rate of Interest. That is, savings expand with the rise in the rate of Interest and when the rate of Interest falls, savings contract. It must be noted that the saving-function or the supply of savings curve is an upward-sloping curve.