merged

Example 2C: Assume the same facts as Example 2A, except that Wenona’s now has to pay an
interest rate of 9% to finance the investment. Should Wenona’s make the investment?
Rate of return = $900,000 ÷ $12,000,000 = .075 or 7.5%
Since the expected rate of return (7.5%) is less than the interest rate (9%), no, Wenona’s should
not make the investment.
As seen in the examples above, the two factors that affect investment spending are:
a. Expectations about future returns. If businesses become more optimistic about future
returns, investment spending will increase. If businesses become more pessimistic about
future returns, investment spending will decrease.
b. Interest rates. If interest rates decrease, investment spending will increase. If interest rates
increase, investment spending will decrease.
3. Government purchases. The amount of government purchases is determined through the
political process.
Example 3: If the federal government decides to increase military spending, or if state
governments decide to provide more funding for education, or if local governments decide to
increase funding for police and fire protection, government purchases will increase.
4. Net exports. Net exports (exports minus imports) will change if there is a change in foreign
Real GDP or if there is a change in the exchange rate for a nation’s currency. More
specifically;
a. A change in foreign Real GDP. Net exports will increase if there is an increase in foreign
Real GDP. If U.S. trading partners experience economic growth, they will consume more
U.S. exports. Conversely, net exports will decrease if there is a decrease in foreign Real
GDP. If U.S. trading partners experience economic recession, they will consume less U.S.
exports.
Example 4A: The largest trading partner for the U.S. is Canada. If the Canadian economy is
growing rapidly, Canadian demand for U.S. exports will increase. If the Canadian economy falls
into recession, Canadian demand for U.S. exports will decrease.
b. A change in the exchange rate for a nation’s currency. The exchange rate is the value
of one nation’s currency in terms of another nation’s currency. For example, on November
12, 2014, one U.S. dollar would exchange for 1.129 Canadian dollars.
If the exchange rate for the U.S. dollar depreciates (decreases relative to other currencies),
U.S. exports will be cheaper and imports to the U.S. will be more expensive. Thus, net
exports will increase if the exchange rate for the dollar depreciates.
If the exchange rate for the U.S. dollar appreciates (increases relative to other currencies),
U.S. exports will be more expensive and imports to the U.S. will be cheaper. Thus, net
exports will decrease if the exchange rate for the dollar appreciates.
Example 4B: If the U.S. dollar depreciates versus the Canadian dollar, U.S. exports to Canada
would increase and U.S. imports from Canada would decrease. If the U.S. dollar appreciates
versus the Canadian dollar, U.S. exports to Canada would decrease and U.S. imports from
Canada would increase.
FOR REVIEW ONLY - NOT FOR DISTRIBUTION
Another factor that can affect aggregate demand is the money supply. In the long run, aggregate
demand tends to be closely related to the money supply. The money supply will be discussed in
later chapters.
6 - 3 The Aggregate Market