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Chapter 27: Problem 19

Use the following news clip to work Problems 19 and 20 Spending by Women Jumps The magazine Women of China reported that Chinese women in big cities spent \(63 \%\) of their income on consumer goods last year, up from \(26 \%\) in \(2007 .\) Clothing accounted for the biggest chunk of that spending, at nearly \(30 \%\), followed by digital products such as cellphones \((11 \%)\) and travel \((10 \%)\) Chinese consumption as a whole grew faster than the overall economy and is expected to reach \(42 \%\) of GDP by \(2020,\) up from the current \(36 \%\) Explain the effect of a rise in consumption expenditure on real GDP and the price level in the short run.

Short Answer

Expert verified
A rise in consumption expenditure increases real GDP and the price level in the short run.

Step by step solution

01

Understanding Consumption Expenditure

Consumption expenditure refers to the amount of money spent by households on goods and services. When consumption expenditure increases, it implies that consumers are purchasing more goods and services.
02

Impact on Aggregate Demand

An increase in consumption expenditure raises aggregate demand (AD). Aggregate demand is the total demand for final goods and services in an economy at a given time and price level. When AD increases, it shifts the aggregate demand curve to the right.
03

Short-run Effect on Real GDP

In the short run, an increase in aggregate demand typically leads to an increase in real GDP. This is because higher demand for goods and services encourages businesses to produce more, utilizing existing resources more fully and potentially hiring more workers.
04

Short-run Effect on Price Level

With higher aggregate demand, the increased competition for goods and services can lead to higher prices, causing the price level to rise. This effect is represented as a movement upward along the aggregate supply curve, leading to demand-pull inflation.
05

Conclusion on the Short-run Effects

In summary, a rise in consumption expenditure in the short run generates a higher real GDP and an increase in the price level due to heightened aggregate demand.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

aggregate demand
Aggregate demand (AD) represents the total quantity of goods and services demanded across all levels of an economy at a given price level and time period. It includes consumption, investment, government spending, and net exports. When consumption expenditure rises, AD increases because households are spending more on goods and services.
This increase in spending shifts the AD curve to the right. A rightward shift means higher demand in the economy, which can prompt businesses to increase production to meet this demand.
  • Greater spending leads to higher demand for products
  • Businesses may need to hire more workers, utilizing resources more efficiently
The relationship between AD and the price level is vital. If demand rises sharply, it can influence how prices adjust across the economy.
real GDP
Real Gross Domestic Product (GDP) is a measure of the value of all final goods and services produced within a country in a given period, adjusted for inflation. It's crucial for assessing the health of an economy.
In the short run, when aggregate demand increases due to higher consumption expenditure, the real GDP tends to rise. This is because:
  • Businesses ramp up production to meet the higher demand
  • Increased production typically requires more labor, leading to higher employment
  • More employment means more income, further boosting consumption
Thus, higher consumption expenditure logically translates to a more robust real GDP in the short term. However, it's essential to monitor other economic factors, such as resource availability, to ensure sustainable growth.
price level
The price level indicates the average of all current prices for goods and services in an economy. It's measured by various price indices like the Consumer Price Index (CPI).
When aggregate demand increases, the competition for goods and services can push prices up. This phenomenon is known as demand-pull inflation. In the context of higher consumption expenditure:
  • More spending increases the demand for goods and services
  • Businesses may raise prices to balance supply and demand
  • Higher prices contribute to an overall increase in the price level
Increased consumption often leads to a higher price level, making it essential for policymakers to balance demand with supply to avoid excessive inflation.
consumer behavior
Consumer behavior refers to the decisions and actions that influence the purchasing habits of individuals or households. Factors like income, preferences, and market trends shape how consumers spend their money.
In the exercise, Chinese women increased their consumption expenditure significantly in recent years. Key drivers for this change could include:
  • Higher disposable incomes
  • Greater availability of consumer goods
  • Shifts in cultural or social preferences
Understanding consumer behavior helps economists predict changes in consumption patterns, aiding in better economic forecasting and policy-making. As seen here, a rise in consumption can have far-reaching effects on aggregate demand, GDP, and price levels.
demand-pull inflation
Demand-pull inflation occurs when the demand for goods and services exceeds their supply, leading to higher prices. This type of inflation is driven by increased consumption, investment, government spending, or net exports.
In the context of the exercise, heightened consumption expenditure by Chinese women contributed to an increase in aggregate demand. As a result:
  • Businesses strive to meet higher demand by increasing production
  • More competition for limited goods and services pushes prices up
  • The rise in prices reflects demand-pull inflation
This kind of inflationary pressure is typical when an economy is growing quickly, underlining the importance of managing demand and supply.
short-run economic effects
In the short run, changes in aggregate demand can have significant effects on the economy. When consumption expenditure rises, these effects include.
Higher Real GDP: Increased consumption promotes higher production levels, boosting GDP.
Demand-Pull Inflation: The increased competition for goods and services can lead to higher prices.
Employment Growth: Businesses may hire more workers to meet the higher demand.
  • Increased production and employment boost overall economic activity
  • The rise in incomes from more jobs can further drive consumption
  • However, these changes must be managed to prevent overheating or excessive inflation
Understanding these short-run effects is crucial for economic planning and policy-making to maintain a balanced and healthy economy.

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Most popular questions from this chapter

Use the following information to work Problems \(14-16\) According to the East Asia and Pacific Economic Update published by the World Bank in April 2015 the following factors have affected China's real GDP in 2015 Global economic recovery supports a moderate increase in China's exports. China benefits from a fall in the world price of oil Chinese government to cut excess capacity in heavy industry. U.S. firms to relocate their labor-intensive manufacturing industries to low-cost countries. Explain how each factor separately affect China's real GDP and the price level, starting from a position of long-run equilibrium.

Brazil Falls into Recession A decade ago Brazil had rapid growth, but now its economy is experiencing a slowdown with investment falling and inventories increasing. Potential GDP growth rate has slowed. Business and consumer confidence has fallen. Source: BBC News, August 29, 2014 a. Explain the effect of a decrease in investment on real GDP and potential GDP. b. Explain how business and consumer confidence influences aggregate expenditure.

Labor productivity is rising at a rapid rate in China and wages are rising at a similar rate. Explain how a rise in labor productivity and wages in China will influence the quantity of real GDP supplied and aggregate supply in China.

Cut Taxes and Boost Spending? Raise Taxes and Cut Spending? Cut Taxes and Cut Spending? This headline expresses three views about what to do to get the U.S. economy growing more rapidly and contribute to closing the recessionary gap. Economists from which macroeconomic school of thought would recommend pursuing policies described by each of these views?

Canada trades with the United States. Explain the effect of each of the following events on Canada's aggregate demand. The government of Canada cuts income taxes.The United States experiences strong economic growth. Canada sets new environmental standards that require power utilities to upgrade their production facilities.
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