Question

Assignment Instructions 1. State at least TWO determinants of each of the components of the AD, namely consumption, investment and net exports. 2. With help of the AD-AS diagram, explain briefly how a change in the determinants stated above may change the AD and consequently the macroeconomic equilibrium

Answer 1

1. Determinants of Consumption spending:

A) increase in income - Consumers have more money to spend. So, Consumption spending will increase. It will decrease if income decreases.

B) Future expectations- if Consumers expects price of good to be lower in the future, then they will purchase more in future and less in today's period. So, Consumption spending in today's period will decrease.

Determinants of Investment:

A) expectations- an expectation that there'll be sharp upsurge in the level of economic activity in future will increase investment spending, because expected rates of return increases. The opposite is true when business expects a reduction in economic activity.

B) Technology advancement increases investment spending and decline in technology, which is very unlikely, will decrease investment spending.

Determinants of net export:

A) exchange rate: A depreciation of domestic currency will decrease import (because foreign goods become costlier) and increase export (as foreigners find domestic goods cheaper). This will increase net export (net export = export - import).

The opposite happens if domestic currency appreciates in terms of foreign currency.

B) if more money is spent on imports than the payment received from export, then net export decreases.