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Chapter 27: Problem 1

A fall in the value of the dollar against other currencies makes U.S. final goods and services cheaper to foreigners even though the U.S. aggregate price level stays the same. As a result, foreigners demand more American aggregate output. Your study partner says that this represents a movement down the aggregate demand curve because foreigners are demanding more in response to a lower price. You, however, insist that this represents a rightward shift of the aggregate demand curve. Who is right? Explain.

Short Answer

Expert verified
Answer: A rightward shift of the aggregate demand curve.

Step by step solution

01

Review the concept of aggregate demand

Aggregate demand represents the total demand for all final goods and services produced within the economy at different price levels. It is the sum of consumption, investment, government spending, and net exports. The aggregate demand curve shows the relationship between the price level and the quantity of real GDP demanded, with all other factors held constant.
02

Understand movement along the aggregate demand curve and shifts in the curve

A movement along the aggregate demand curve occurs when there is a change in the price level, which causes the quantity of real GDP demanded to change while holding all other factors constant. This movement does not alter the overall shape or position of the curve. On the other hand, a shift in the aggregate demand curve occurs when there is a change in any non-price determinant of aggregate demand, such as income levels, expectations, or interest rates. This results in a new aggregate demand curve at a different position.
03

Analyze the given scenario

In the given scenario, the fall in the value of the dollar against other currencies has not changed the U.S. aggregate price level. Instead, it has made the U.S final goods and services cheaper for foreigners. This results in an increase in demand for U.S. aggregate output from foreigners, which increases the total demand for U.S. goods and services.
04

Determine if the scenario represents a movement along or a shift in the aggregate demand curve

Since there is no change in the U.S. aggregate price level and the increase in demand is caused by a change in a non-price determinant (exchange rate), the scenario represents a rightward shift of the aggregate demand curve, not a movement along the curve.
05

Evaluate the original argument

Given the analysis, your position that this represents a rightward shift of the aggregate demand curve is correct. The increase in demand by foreigners for U.S. goods and services due to the fall in the value of the dollar represents a change in a non-price determinant, leading to a shift in the curve rather than a movement along it.

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Most popular questions from this chapter

The Conference Board publishes the Consumer Confidence Index (CCI) every month based on a survey of 5,000 representative U.S. households. It is used by many economists to track the state of the economy. A press release by the Board on June \(28,2011,\) stated: "The Conference Board Consumer Confidence Index, which had declined in May, decreased again in June. The Index now stands at \(58.5(1985=100)\), down from 61.7 in May." a. As an economist, is this news encouraging for economic growth? b. Explain your answer to part a with the help of the \(A D-A S\) model. Draw a typical diagram showing two equilibrium points \(\left(E_{1}\right)\) and \(\left(E_{2}\right) .\) Label the vertical axis "Aggregate price level" and the horizontal axis "Real GDP." Assume that all other major macroeconomic factors remain unchanged. c. How should the government respond to this news? What are some policy measures that could be used to help neutralize the effect of falling consumer confidence?

Explain whether the following government policies affect the aggregate demand curve or the short-run aggregate supply curve and how. a. The government reduces the minimum nominal wage. b. The government increases Temporary Assistance to Needy Families (TANF) payments, government transfers to families with dependent children. c. To reduce the budget deficit, the government announces that households will pay much higher taxes beginning next year. d. The government reduces military spending.

In each of the following cases, in the short run, determine whether the events cause a shift of a curve or a movement along a curve. Determine which curve is involved and the direction of the change. a. As a result of an increase in the value of the dollar in relation to other currencies, American producers now pay less in dollar terms for foreign steel, a major commodity used in production. b. An increase in the quantity of money by the Federal Reserve increases the quantity of money that people wish to lend, lowering interest rates. c. Greater union activity leads to higher nominal wages. d. A fall in the aggregate price level increases the purchasing power of households' and firms" money holdings. As a result, they borrow less and lend more.

Suppose that the economy is currently at potential output. Also suppose that you are an economic policy maker and that a college economics student asks you to rank, if possible, your most preferred to least preferred type of shock: positive demand shock, negative demand shock, positive supply shock, negative supply shock. How would you rank them and why?

Suppose that all households hold all their wealth in assets that automatically rise in value when the aggregate price level rises (an example of this is what is called an "inflation-indexed bond"-a bond whose interest rate, among other things, changes one-for-one with the inflation rate). What happens to the wealth effect of a change in the aggregate price level as a result of this allocation of assets? What happens to the slope of the aggregate demand curve? Will it still slope downward? Explain.
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