Econ Chapter 23 Lecture Notes:
What Happens if the Price Level Rises?
Changes in Consumption:
-When prices rise, the money that people hold can buy fewer goods.
-People are effectively poorer and consumption falls.
-A rise in the price level lowers the real value of money.
-Similarly, a fall in the price level raises the real value of money.
C = a + b(1 - t)Y
-A rise in the price level leads to a decrease in wealth and in autonomous
consumption (reduction in a) and to a downward shift in the AE function.
-A fall in the price level leads to a rise in wealth and in autonomous consumption
(increase in a) and to an upward shift in the AE function.
Changes in Exports:
-When the domestic price level rises, Canadian goods become more expensive
relative to foreign goods.
-Consumers in other countries reduce their purchases of Canadian-made goods.
-A rise in the domestic price level shifts the export function downward, which causes a
downward shift in the AE curve.
-Similarly, a fall in the domestic price level shifts the net export function upward and
the AE curve upward.
Aggregate Expenditure and the Price Level:
-An exogenous increase in the price level causes the AE curve to shift downward from
AE0 to AE1.
-The equilibrium changes from E0 to E1 and real GDP falls from Y0 to Y1.