KW_Macro_Ch_10_Sec_03_The_Multiplier

KW_Macro_Ch_10_Sec_03_The_Multiplier - chapter 10 Aggregate...

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>> Aggregate Supply and Aggregate Demand Section 3: The Multiplier chapter 10 Suppose that businesses become more optimistic about future sales and increase investment spending by $50 billion. This shifts the aggregate demand curve right- ward—increasing the quantity of aggregate output demanded at any given aggregate price level. But suppose that we want to know how much the aggregate demand curve will shift to the right. To answer that question we use the concept of the multiplier, which plays an important role in the analysis of economic policy. When we ask how far to the right a $50 billion increase in investment spending shifts the aggregate demand curve, what we really want to know is the magnitude of the shift shown in Figure 10-8: The increase in the quantity of aggregate output demanded at a given aggregate price level, P *. We will hold the aggregate price level constant. (This means, among other things, that there is no difference between changes in nominal GDP and changes in real GDP.) We’ll also make some addition- al simplifying assumptions: we’ll hold the interest rate constant, and we’ll ignore the roles of taxes and foreign trade, reserving those issues for later chapters.
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Assuming a constant aggregate price level and a fixed interest rate, you might be tempted to say that a $50 billion increase in investment spending will shift the aggregate demand curve to the right by $50 billion. That, however, is an underestimate. It’s true that an increase in investment spending leads firms that produce investment goods to increase output. If the process stopped there, then the rightward shift of the AD curve would indeed be $50 billion. 2 CHAPTER 10 SECTION 3: THE MULTIPLIER Figure 10-8 Agg r egate p r ice level AD 2 AD 1 Real GDP Size of rightward shift of AD curve given aggregate price level P* P * Y 1 Y 2 Measuring Shifts of the AD Curve To measure the shift that takes place when the aggregate demand curve shifts rightward from AD 1 to AD 2 , we calculate how much real GDP would rise if we held the aggregate price level fixed at P *.
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But the process doesn’t stop there. The increase in output leads to an increase in disposable income that flows to households in the form of profits and wages. The increase in households’ disposable income leads to a rise in consumer spending, which, in turn, induces firms to increase output yet again. This generates another rise in disposable income, which leads to another round of consumer spending increases, and so on. So there are multiple rounds of increases in aggregate output.
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KW_Macro_Ch_10_Sec_03_The_Multiplier - chapter 10 Aggregate...

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