For the following questions use the diagram below Figure 347

For the following questions, use the diagram below Figure 34-7 AS LRAS Price Level AD1 ADa of Output Refer to Figure 34-7 The aggreg gate-demand curve could shift from ADi to AD: as a result of an increase an goseroment purchases b a decrease in nset esport c households saring a smaller fraction of their income in the price level

Solution

The components of aggregate demand (AD) are as follows: AD= C+I+G+NX where C: Consumption, I: Investment, G: Government Spending and NX: Net Exports.

If Government purchases rises, then G should rise which should raise AD and not reduce it.

If household saves a smaller fraction of income, then it spends or consumes more, which should raise C and raise AD and not reduce it.

Price level and AD are inversely related. A downward slope of AD implies that when price level falls, AD should rise and not fall.

However, when net exports decreases, the ‘NX’ component of the AD function falls which reduces AD and shifts AD leftward to AD2.

Therefore the correct option is:

b) a decrease in net exports