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Principles of Macroeconomics (Mind...

7th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781285165912

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Principles of Macroeconomics (Mind...

7th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781285165912
Chapter 20, Problem 6QR
Textbook Problem
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What might shift the aggregate-demand curve to the left? Use the model of aggregate demand and aggregate supply to trace through the short-run and long-run effects of such a shift on output and the price level.

To determine
What factors cause leftward shifts in the aggregate demand.

Explanation of Solution

The demand comes from all economic agents such as households, firms, and the government. The demand is dependent on the price level of the economy. The increase and decrease in the price level determines the level of demand in the economy. The aggregation of all the individual demands in the economy is known as the aggregate demand; thus, the aggregate demand explains the relationship between the general price level and the level of real GDP demanded in the economy by the economic agents such as households, firms, and the government.

There are many factors that cause the leftward shift in the AD. They are: the changes in the interest rates, government purchases, different taxes, future expectations of households and firms, growth rate of domestic GDP and exchange rate, and so forth. They are explained below.

The interest rate is an important aspect in determining the shift in the AD curve. When there is an increase in the interest rate in the economy, the consumption expenditure as well as the investment expenditure will start to decline because the people will save more in order to earn more interest than investing and spending. This decrease in the investment and consumption spending will shift the AD curve to the left and vice versa, when there is a fall in the interest rate in the economy.

When there is an increase in government purchases, it will lead to an increase in the aggregate spending of the economy. As a result of the increase in the government spending, there will be a direct shift in the AD curve towards the right (and vice versa) when the government spending decreases.

Similarly, the taxes are the unilateral payments made by the public to the government;  when there is an increase in the personal income taxes, it will reduce the consumption expenditure of the individuals and as a result, the AD of the economy will shift towards the left and vice versa. Likewise, when the business taxes increases, it reduces the investment spending of the firms and the AD will shift to the left, as in the case of the personal income taxes...

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