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4 Question about Aggregate Demand Curve

1. What is the effect of an increase in the quantity of money? What is the difference between real variables and nominal variables? Are these variables affected by the quantity of money? If so, how?

2. What is the difference between the real exchange rate and the nominal exchange rate? If the nominal exchange rate goes from 120 to 160 pesos per dollar, what has happened to the value of a dollar?

3. Why does the aggregate demand curve slope downward? Give at least three reasons and examples when addressing this question. Identify an event that would shift the AD curve and which direction the AD curve will shift.

4. Assume that the federal government increases spending on public works programs, such as highway construction, by $40 billion. How does this change in spending affect the aggregate demand curve? Explain why the shift may be higher or lower than the original $40 billion.

Solution Preview

1. The effect of an increase in the quantity of money is different in the long and short run. In the long run, it is generally agreed that an increase in the quantity of money, all else being equal causes prices to increase. In the short run, an increase in the quantity of money may cause an increase in spending and thus consumption. This helps us understand the difference between a real and a nominal variable. A nominal variable is not adjusted for inflation. For instance, the nominal price of most household goods has risen markedly over the past 50 years. However, if one tracks these prices against measures of the overall price level, it is possible to adjust those prices for inflation. This is how one arrives at a real variable. Thus, if the sticker price of a tomato rises by 20% while the overall price level in the economy also rises by 20%, then the nominal price of the tomato has increased while the real price has not. Since an increase in the quantity of money, all else equal, tends to raise prices in the long run, the ...

Solution Summary

The effect of an increase in the quantity of money is explained among other things in answer to these 4 questions, using 701 words with reference links.

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