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Understanding the Multiplier and Price Level Relationship
Dive into the fascinating world of economics! Learn how price levels impact aggregate expenditure and demand, and gain valuable insights for analyzing economic trends and making informed decisions.

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Now Playing:Relations between the multiplier and price level – Example 0a
Intros
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  1. Aggregate Expenditure & Demand with Price Level
    • Wealth Effect
    • Substitution Effect
    • Changes in Price Level
    • Changes in Aggregate Expenditure
  2. Aggregate Expenditure & Demand without Price Level
    • Shifting AEAE Curve
    • Increase in Investment
    • Finding Shift of ADAD Curve
Consumption & saving plans, and marginal propensity
Jump to:NotesConceptFAQsPrerequisites
Notes

Aggregate Expenditure & Demand with Price Level

Price levels can affect how the aggregate expenditure changes, and how the aggregate demand moves.

Recall that the aggregate demand curve is downward sloping for two reasons:

Relations Between the Multiplier & Price Level

  1. Wealth Effect: the higher the price level, the lower your purchasing power is. Therefore, people would spend less money on goods overall and save more.

  2. Substitution Effect: The higher the price level of US goods, the less exports they will be, and the more imports we will have (due to cheaper prices on foreign foods).

Therefore, price level does two things:
  1. when price level rises, these effects will decrease aggregate expenditure, causing it to shift downwards .

  2. when price level falls, these effects will increase aggregate expenditure, causing it to shift upwards.

Relations Between the Multiplier & Price Level

However, aggregate demand does not shift, it only moves along the curve.

Aggregate Expenditure & Demand without Price Level

Other influences (that are not price level) can also affect how aggregate expenditure and aggregate demand change.

Suppose we have our AEAE curve and the equilibrium expenditure is at 10.5 trillion.

Relations Between the Multiplier & Price Level

Let’s say that there is a $0.5 trillion increase in investment, causing the aggregate expenditure to shift up.

Relations Between the Multiplier & Price Level

A new equilibrium expenditure has been achieved.

However, since real GDP has increased without a change in the price level, the aggregate demand curve shifts to the right.

Relations Between the Multiplier & Price Level

Note: the aggregate demand shifts by how much the multiplier is.

Shift  in  AD  Curve=Δautonomous  expenditure×MultiplierShift\; in\; AD\; Curve = \Delta autonomous\; expenditure \times Multiplier


Changes in the Aggregate Demand

Though we talked about aggregate demand, we also need to add in aggregate supply so that we can find the equilibrium real GDP and price level.

To do so, we need to add two-time frames: short-run & long-run.

Short Run: Suppose we have our AEAE curve and the equilibrium expenditure is at 10.5 trillion.

Relations Between the Multiplier & Price Level

Let’s say that there is a $0.5 trillion increase in investment, causing the aggregate expenditure to shift up.

Relations Between the Multiplier & Price Level

A new equilibrium expenditure has been achieved.

However, since real GDP has increased without a change in the price level, the aggregate demand curve shifts to the right.

Relations Between the Multiplier & Price Level

Eventually, price level must rise so that aggregate demand and supply can reach equilibrium.

Relations Between the Multiplier & Price Level

Since price level has risen, the aggregate expenditure decreases and shifts downward, giving a new equilibrium expenditure.

Relations Between the Multiplier & Price Level

Long Run: Suppose we have the exact same scenario as the short-run, but now we add the long-run aggregate supply curve.

Relations Between the Multiplier & Price Level

Notice that real GDP > potential GDP, so we are in an inflationary gap and at above full employment. At high price levels, workers want more money, causing the supply curve to decrease. This shifts to the supply curve to the left.

Relations Between the Multiplier & Price Level

We see that the new equilibrium increases the price level, which decreases aggregate expenditure down back to the original (AE2 to AE0)

Relations Between the Multiplier & Price Level

Note: In the long run, the multiplier is equal to 1 because we went back to the original AEAE curve.
Concept

Introduction: The Relationship Between Price Level, Aggregate Expenditure, and Aggregate Demand

Welcome to our exploration of how price level influences aggregate expenditure and aggregate demand! These economic concepts are crucial for understanding the bigger picture of how an economy functions. Our introduction video serves as an excellent starting point, providing a clear and concise overview of these relationships. As we delve into this topic, you'll discover that price level plays a significant role in shaping consumer and business spending decisions. When prices rise, purchasing power decreases, leading to a reduction in aggregate expenditure. This, in turn, affects aggregate demand, which represents the total demand for goods and services in an economy. The video will help you visualize these connections, making it easier to grasp how changes in one factor can ripple through the entire economic system. By understanding these concepts, you'll be better equipped to analyze economic trends and make informed decisions. Let's dive in and unravel the fascinating world of price levels, aggregate expenditure, and aggregate demand together!

FAQs

1. How does a change in price level affect aggregate expenditure?
A change in price level directly impacts aggregate expenditure. When prices decrease, consumers' purchasing power increases, leading to higher aggregate expenditure. Conversely, when prices increase, purchasing power decreases, resulting in lower aggregate expenditure. This relationship is reflected in the upward or downward shift of the Aggregate Expenditure (AE) curve.

2. What is the multiplier effect and how does it relate to price level changes?
The multiplier effect describes how an initial change in spending leads to a larger change in national income. It's calculated as 1 / (1 - MPC), where MPC is the Marginal Propensity to Consume. Price level changes can trigger the multiplier effect. For example, if prices fall, increased purchasing power can lead to higher consumption, which then multiplies through the economy, resulting in a larger overall increase in aggregate demand.

3. How do long-run effects of price level changes differ from short-run effects?
In the short run, price level changes can cause movements along the Aggregate Demand (AD) and Short-Run Aggregate Supply (SRAS) curves. However, in the long run, the economy tends to return to its potential GDP level, regardless of short-term fluctuations. The Long-Run Aggregate Supply (LRAS) curve is vertical, meaning it doesn't change with price level changes. Long-run adjustments involve shifts in SRAS as prices, wages, and resource costs adjust proportionally.

4. What is the relationship between price level and employment?
In the short run, unexpected price increases might lead to higher employment as businesses see higher profits and hire more workers. Conversely, sudden price decreases might lead to layoffs. However, in the long run, labor markets adjust. If prices remain high, workers demand higher wages, potentially reducing employment. If prices stay low, wages might decrease, potentially increasing employment as labor becomes more affordable for businesses.

5. How do policymakers use their understanding of price level changes to manage the economy?
Policymakers use their knowledge of price level changes to implement monetary and fiscal policies. For instance, central banks may adjust interest rates to control inflation or stimulate spending. Governments might increase public spending or offer tax incentives to boost aggregate demand during deflationary periods. The goal is to maintain economic stability by balancing price stability with maximum employment, often through inflation targeting and other economic tools.

Prerequisites

Understanding the relations between the multiplier and price level is a crucial aspect of macroeconomics. While there are no specific prerequisite topics provided for this subject, it's important to recognize that a strong foundation in basic economic principles is essential for grasping this complex relationship. Students should be familiar with concepts such as aggregate demand, aggregate supply, and the overall functioning of the economy.

The multiplier effect and price level interactions are integral components of economic analysis. To fully comprehend these relations, one must have a solid understanding of how changes in spending can have a magnified impact on the economy. This concept is closely tied to the idea of economic equilibrium and how various factors can influence it.

Although not explicitly listed as prerequisites, topics such as monetary policy, fiscal policy, and inflation play significant roles in shaping the relationship between the multiplier and price level. These areas of study provide context for how government actions and market forces can influence economic outcomes.

Students should also be comfortable with basic mathematical concepts and graphical representations, as these tools are often used to illustrate the multiplier effect and its interaction with price levels. The ability to interpret economic models and data is crucial for a deeper understanding of this topic.

Furthermore, an awareness of historical economic events and their impacts can greatly enhance one's comprehension of the multiplier and price level relationship. Real-world examples often serve to illustrate theoretical concepts more effectively.

While specific prerequisites are not provided, it's clear that a well-rounded knowledge of fundamental economic principles is vital. Students should approach this topic with curiosity and a willingness to connect various economic concepts. The interplay between the multiplier and price level is a dynamic area of study that requires critical thinking and the ability to synthesize information from multiple economic perspectives.

As you delve into this subject, remember that economics is an interconnected field. The relations between the multiplier and price level do not exist in isolation but are part of a broader economic framework. By cultivating a comprehensive understanding of economic principles, you'll be better equipped to analyze and interpret these complex relationships.

In conclusion, while there may not be a definitive list of prerequisites for this topic, a strong foundation in economic theory and practice is invaluable. Approach the study of the relations between the multiplier and price level with an open mind, ready to draw connections between various economic concepts and real-world applications. This holistic approach will not only enhance your understanding of this specific topic but also contribute to your overall economic literacy.