Check Your Understanding

Questions

1. Explain why decreases in income tax, savings and import spending all increase aggregate
demand.
Lower income taxes, savings and import bills all lead to higher aggregate demand. The reason is
that income taxes, savings and imports are all withdrawals from marginal propensity to consume.
The marginal propensity to consume increases as income taxes, savings and imports decrease. If
the MPC is higher than the multiplier, the multiplier will be higher. The multiplier causes initial
investment to further increase total consumption. Thus, lower income taxes, savings, and import
expenditures all lead to higher aggregate demand.

2. How does a change in the interest rate influence the aggregate demand curve?
Impact of change in interest rate on aggregate demand curve. A fall in interest rates causes the
aggregate demand curve to move up. It means that aggregate demand increases when interest
rates fall. The reason is that people are less inclined to keep their money in the bank and keep
themselves liquid at low-interest rates. Total expenditure increased.

3. If the value of the Canadian dollar decreases, what is the likely impact on aggregate demand?
If the Canadian dollar depreciates, aggregate demand will increase. The reason is that as the
Canadian dollar falls, exports become cheaper and imports more expensive. Reduce imports,
increase MPC, if MPC is higher than multiplier will be higher. The multiplier leads to initial
investment, which further increases total consumption.

4. Why is a shift of the aggregate supply curve to the right like an outward shift of the production
possibilities curve?
This is because the increase in the aggregate supply curve represents the increase in production,
and the outward transfer of the production possibility curve also reflects the increase in
production caused by the increase in resource efficiency.