Can someone please explain me if my understanding about the following text is correct?
The AD curve will be flatter if
■■ investment expenditure is highly sensitive to the interest rate;
■■ saving is insensitive to income;
■■ money demand is insensitive to interest rates; and
■■ money demand is insensitive to income.
What is meant by insensitivity of savings to income? And how all above factors influence the slope of AD Curve
Thanks a lot in a
Think all of it in terms of variations. If X variates, how much Y variates?
A flatter AD curve would mean that aggregate demand is more sensitive to prices of goods and services. A slight change in prices will generate a big movement in quantity demanded.
What are the components of AD:
AD = Comsumption + Investment + Gov Spending + Exports - Imports
So now let’s check if all of the 4 statements comply with (1):
■■ investment expenditure is highly sensitive to the interest rate: The higher the interest rates, the lower the investment and viceversa. If investments are very senstive to interest rates, then any slight movement of rates will generate big movements in the investment level. So this statement comply with a flatter AD curve.
■■ saving is insensitive to income: If savings are not a proportion (%) of income, so are mostly fixed, then savings level will no move with income level. Therefore, a higher income will create a disposable income higher than proportionaly that it would have been if savings were sensitive to income. In simple terms, if ppl have more money, they are less sensitive to prices, therfore this would not help to a flat AD curve, but a steeper one.
■■ money demand is insensitive to interest rates: Again, as above, If people keep borrowing money despite high interest rates (have more money), they are less sensitive to prices, therefore this would not help to a flat AD curve, but a steeper one.
■■ money demand is insensitive to income: Supposedly, money demand is sensitive to income because the higher the income, the more money you need to hold to keep making transactions. If money demand is insensitive to income, it would mean people saves a lot, or consumes extra a little when income becomes higher. So this case would be the opposite of the 2nd case above and therefore AD will be sensitive to prices and help to build a flat AD curve.
Let me know what do you think and if you have finally checked from the source.
Please note that what I have done here is known as “Static Analysis”, not a dynamic analysis, because we are seeing movements along the AD curve, not movements of the curve itself (expands or contracts).
Hope this helps.