study Guide Econ 101 #3
Principles of MacroEconomics: 101
Problem Set #3: Answer Key
1. Explain each of the following: (a) the wealth effect, (b) interest rate effect, and (c) international trade effect.
The real balance effect states that the inverse relationship is established through changes in the value of monetary wealth. As the price level changes, the purchasing power of monetary wealth changes, causing the quantity demanded of Real GDP to change.
The interest rate effect states that the inverse relationship is established through changes in household and business spending that is sensitive to interest rate changes. As the price level changes, it takes a different quantity of money to purchase a fixed bundle of goods, and this leads to a change in savings (the supply of credit increases). Subsequently, the price of credit, which is the interest rate, changes, causing households and businesses to change their borrowing levels, and changing the quantity of Real GDP to change.
The international trade effect states that the inverse relationship is established through foreign sector spending. As the price level in the U.S. changes, U.S. goods become relatively cheaper or more expensive than foreign goods. As a result, Americans and foreigners change the amounts of U.S. goods they buy, changing the quantity of Real GDP to change.
2. Explain what happens to the 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.
In examples (a), (b), (d), and (e), the aggregate demand curve would shift to the left, causing both Real GDP and the price level to decrease in the short run. In (c), the aggregate demand curve would shift to the right, causing both Real GDP and the price level to increase in the short run.
3. Explain what is likely to happen to U.S. export and import
Problem Set #3: Answer Key
1. Explain each of the following: (a) the wealth effect, (b) interest rate effect, and (c) international trade effect.
The real balance effect states that the inverse relationship is established through changes in the value of monetary wealth. As the price level changes, the purchasing power of monetary wealth changes, causing the quantity demanded of Real GDP to change.
The interest rate effect states that the inverse relationship is established through changes in household and business spending that is sensitive to interest rate changes. As the price level changes, it takes a different quantity of money to purchase a fixed bundle of goods, and this leads to a change in savings (the supply of credit increases). Subsequently, the price of credit, which is the interest rate, changes, causing households and businesses to change their borrowing levels, and changing the quantity of Real GDP to change.
The international trade effect states that the inverse relationship is established through foreign sector spending. As the price level in the U.S. changes, U.S. goods become relatively cheaper or more expensive than foreign goods. As a result, Americans and foreigners change the amounts of U.S. goods they buy, changing the quantity of Real GDP to change.
2. Explain what happens to the 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.
In examples (a), (b), (d), and (e), the aggregate demand curve would shift to the left, causing both Real GDP and the price level to decrease in the short run. In (c), the aggregate demand curve would shift to the right, causing both Real GDP and the price level to increase in the short run.
3. Explain what is likely to happen to U.S. export and import