Answer to Question #130474 in Macroeconomics for Hafsa Tahir

Question

What is the effect of higher price level on the economy's aggregate expenditure line in terms of real gdp

Answer 1

An aggregate expenditures curve assumes a fixed price level. If the price level changes, the levels of consumption, investment, and net exports would all change, producing a new aggregate expenditures curve and a new equilibrium solution in the aggregate expenditures model.

A change in the price level changes people’s real wealth. Suppose, for example, that your wealth includes $20,000 in a bond account. An increase in the price level would reduce the real value of this money, reduce your real wealth, and thus reduce your consumption. Therefore it can be deduced that,

an increase in the price level would reduce aggregate expenditures.