If the real interest rate suddenly increases, it will lead to a decrease in investment spending and thus a decrease in aggregate demand. This is because higher interest rates make it more expensive for firms to borrow money to invest in new projects, causing them to reduce their investment spending.
In the short run, a decrease in aggregate demand will lead to a recessionary gap, which is a situation where the actual output of an economy is below its potential level. This is because during a recessionary gap, there is an excess supply of goods and services in the economy. This results in lower output and higher unemployment, as firms reduce their production levels and lay off workers.
Overall, an increase in the real interest rate leads to a decrease in investment spending and a decrease in aggregate demand, resulting in a recessionary gap in the short run.
Suppose that the real interest rate suddenly increases
for reasons that have nothing to do with the value of the price level. What happens to the nation's aggregate demand curve? In the short run, will the nation experience an inflationary gap or a recessionary gap? Explain.
3 answers
So the aggregate demand curve shift left right
Yes, the aggregate demand curve will shift to the left due to the decrease in investment spending caused by the increase in the real interest rate. This shift to the left represents a decrease in the level of aggregate demand at any given price level. This shift can be visualized as a movement along an upward sloping aggregate supply curve, leading to a lower level of output and a higher price level in the short run.