5. Use an AD/AS diagram to analyze the likely effects of an increase in interest rates.
Interest rate is the opportunity cost of spending money. Increased interest rate generally results in decreased aggregate demand (AD) and the amount of investment in the economy declines because it becomes more expensive to borrow money for firms and households and the amount of repayment rises. People will want to save more and decrease consumption as interest rates rise. The diagram above is a loanable funds market diagram. It basically shows how a higher interest rate IR 1, the demand (investment) is lower.
6. Use an AD/AS diagram to analyze the likely effects of an increase in income tax.
7. Identify the components of aggregate demand and briefly explain two factors which might determine each of these components.
8. Using AD/AS diagrams, analyze the likely impact on an economy of the following:
i. a general rise in wage costs
ii. the discovery of new raw material resources
iii. capital stock increases.