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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