Macroeconomics
1. TheWealthEffect :Ariseinthepricelevel, ceterisparibus , reducesthequantityofgoodsand servicesthatindividualscanbuy.Inaddition,thepurchasingpowerofsavingsheldinbanksand fnancial institutions decreases. 2. The Interest Rate Effect (alsoknownasthesavingseffect) :Ariseinthepricelevelleadstoa higher demandformoneytocovertherisingprices .This,inturn,causesanincreaseininterest rates,whichservesasthecostofborrowing.Higherinterestratestendtodiscourage borrowing and investment , ultimately leading to decreased consumption . The reduced investment and consumption contribute to a decline in real GDP. 3. TheExchangeRateEffect (alsoknownastheinternationaleffect,theforeignexchangeeffect,or the net exports effect): A rise in the domestic price level makes exports less competitive and increases the demand for cheaper imports. This results in a reductioninnetexports(exports minus imports), which is a component of real GDP. Lower netexports,inturn,contributetoa decrease in real GDP. Movements Along the AD Curve Similartotheindividualdemandcurve,theADcurvewitnessesmovementsalongitwhenthepricelevel changes (at the level of the whole economy in this case), ceteris paribus. AnincreaseinthepricelevelreducesrealGDP illustratedbyamovementalongthecurvefromrightto left (contraction along the AD curve). Alternatively, a decrease inthepricelevelincreasesrealGDP illustrated by a movement along the curve from left to right (extension along the AD curve).
Shifts of the AD Curve While a change in the general price level causes movements along the AD curve, other determinants cause it to shift either to the right (increase inAD) or to the left (decrease in AD).
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