Which of the following choices best describes the effects on consumption, investment, and net exports that would result from an increase in the price level, other factors held constant? Consumption Investment Net exports A) Decrease Decrease Decrease B) Decrease Increase Increase C) Increase Increase Increase Answer is A. But if the price level increases, doesnt that mean the aggregate demand increases thus increasing consumption, investment AND Net exports
Tricky Question. Try to understand what is the cause and what is the effect. When C+I+G+(X-M) increase---->AD increases---->Price Level Increases . This is okay, but for this question we are starting from the other way round. 1. When Price Level Increase, things become more expensive. Consumption falls. 2. Net Exports also fall since local goods become expensive relative to foreign goods. 3. I am not sure why investment falls. But I can guess that due to increase in inflation premium, the Required Rate of Return increases leading to a fall in Investment.
Kh.Asif… would it be because the dollar appreciates, and the interest rate goes up and hence the investment would decrease?
Aravinda Wrote: ------------------------------------------------------- > Kh.Asif… would it be because the dollar > appreciates, and the interest rate goes up and > hence the investment would decrease? Yea, that is a possible explanation. But like I said, I am not too confident on what is the exact explanation.
Increase in price level is basically increase in inflation , if that’s so increase in inflation decreases consumption increases interest rate so investment decreases and since things are costly at home so people will sell things at home and buy from outside, net imports will increase and exports will decreases. but how come AD is increasing , looks like AS is decreasing that’s why price level is going up.
Kh.asif, i think you’re right. After thinking about it i think it’s just the order of the events. Because that’s the only explanation… thanks a lot for your insight.
welcome mate. I have a second major in economics in my undergrad, but I can bet that I would have made the same mistake you did if this came in the exam. One of the toughest econ question I saw for level 1 (I appeared this june).