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Economics > 2.2 Variations in economic activity, aggregate demand and aggregate supply > Flashcards

2.2 Variations in economic activity, aggregate demand and aggregate supply Flashcards

1
Q

What is aggregate demand

A

the total spending on goods and services in a period of time at a given average price level

relationship between average price level and real output

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2
Q

Why does the AD curve have a negative slope

A

the total demand from all sectors within the economy

Consumption, investment, government spending and foreign sector

as the average price level of the economy falls, the level output of all these sectors increase

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3
Q

What happens as the average price level falls

A

purchasing power of income and wealth (C + I + G) increases
interest rates decrease so there is more C, I and G
exchange rates of currency will also decrease, the currency depreciates and so there is more exports and less imports

therefore AD will increase

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4
Q

Four components fo AD

A

Consumption
Investment
government spending
foreign sector

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5
Q

What is consumption

A

the total spending by consumers/household sector on domestic goods and services

durable goods - used over a period of time like cars

non-durable goods - used over a short period of time, rice, toilet paper

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6
Q

Investment

A

addition of capital stock to the economy carried out by firms

replacement investment - spending on capital to maintain productivity of existing capital

induced investment - spending on capital to increase output due to an increase in demand in the economy

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7
Q

Government spending

A

the spending on health, education, law and order, defense, transport, housing…. carried out by the federal, state and local government

the amount they spend depends on the governments policies and objectives

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8
Q

Net exports

A

exports (X) - domestic goods and services bought by foreigners = results in an inflow of exports revenue to the country

Imports (M) - goods and services brought from foreign producers = results in an outflow of import expenditure

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9
Q

AD =

A

C + I + G + (X - M)

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10
Q

what changes consumption

A

changes in consumer confidence

changes in interest rates
changes in wealth

changes in personal income taxes

changes in household indebtedness

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11
Q

what happens when consumer confidence is high

A

consumption increases

AD will increase

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12
Q

what happens when consumer confidence is low

A

C will fall

AD will fall

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13
Q

What happens when interest rates are high

A

households save more and borrow less,\

c decreases and AD drops

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14
Q

what happens when interest rates fall

A

households save less and borrow more

C increase

AD increases

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15
Q

what happens when household wealth increases

A

C increases

AD increases

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16
Q

what happens when wealth is lower

A

C decreases

AD decreases

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17
Q

what is disposable income

A

the income left after taxes have been deducted

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18
Q

what happens when personal income decreases

A

households have more disposable income increases

C increases

AD increases

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19
Q

what happens when personal income taxes increases

A

households have less disposable income

C decreases
AD decreases

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20
Q

what happens when household is in more debt

A

less income to spend

c decreases

AD decreases

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21
Q

what happens when household has less debt

A

households have more income to spend

C increases

AD increases

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22
Q

What factors change investment

A

interest rates

business confidence

technology

business taxes

level of corporate indebtedness

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23
Q

what happens when interest rates change

A

Interest rates increases
business borrow less
I decreases
AD decreases

when interest rates fall
business borrow more
I increases
AD increases

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24
Q

what happens when business confidence changes

A

business confidence high

I increases

AD increases

when business confidence is low

I decreases

AD decreases

usually in recession s

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25
Q

what does changes in technology

A

improvements in technology has higher productivity, I increases and AD increases

deterioration in technology, fall in productivity , I decreases and AD decreases

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26
Q

what happens when business taxes change

A

when business taxes fall

I and AD increases

when business taxes rise

I and AD decreases

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27
Q

what happens when the level of corporate indebtedness changes

A

the less debt businesses accumulate, the more they can spend on investment

I and AD increases

the more debt businesses accumulate, the less they can spend on investment

I and AD decreases

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28
Q

What factors affect government spending

A

political priorities

economic priorities

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29
Q

What changes political priorities

A

election campaign promises

national security issues

austerity measures - claims to balance the government budget deficit

general welfare of society

foreign policy issues - aid given to developing countries

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30
Q

What are economic priorities

A

boosting economic growth

G and AD will increase

Maintain stable rate of inflation

G and AD will decrease

Lowering unemployment rate

G and AD will increase

Achieving a more equitable distribution of income and wealth

G and AD will increase

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31
Q

what government policy tools affect AD

A

fiscal policy and monetary policy

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32
Q

what is fiscal policy

A

government policies relating to the use of taxation and government expenditure to influence AD

  • direct taxes
  • indirect taxes
  • government expenditure
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33
Q

what is monetary policy

A

government policies relating to the use of supply of money and the level of interest rates in an economy to influence AD

Lower interest rates and greater supply of money would increase AD

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34
Q

what happens when trading partners experience economy growth

A

foreign demand for our G and S will increase

X and AD increases

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35
Q

what happens when trading partners experience recessions in economy activity

A

foreign demand for our G and S will decrease

X and AD decrease

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36
Q

what happens when domestic national income increases

A

consumer increase their demand for all sort of goods and services so demand for M also increased

M increases, AD decreases

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37
Q

what happens when domestic national income decreases

A

consumers decreases their demand for foreign goods

M decreases and AD increases

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38
Q

what happens when the currency rises (appreciates)

A

imports become cheaper - M increases
Exports become more expensive and decrease

AD decreases

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39
Q

what happens when the currency falls (deppreciates)

A

imports become more expensive - M decreases

exports become cheaper X increases and AD increases

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40
Q

what happens when trading partners adopt more free trade policies

A

demand for X increases so AD increases

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41
Q

what happens when trading partners adopt more protectionist trade policies

A

Demand for X decreases and so does AD

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42
Q

what is aggregate supply AS

A

the total amount of goods and services that all industries in the economy will produce at every given price level

it is the sum of the supply curves of all the industries in the economy

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43
Q

what is the short run

A

the period of tine where prices of factors of production are fixed - particularly wages for labour are fixed

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44
Q

why does the SRAS slope upwards

A

to produce more output, firms have to give workers more incentives to work more, pay more wages

cost of production rise and are passed on to consumers in the form of higher prices, average price level in the economy rises

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45
Q

what causes shifts in SRAS

A

changes in indirect tax and subsidies

supply shocks

changes in the prices of factors of production

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46
Q

what happens if FAPs Increase

A

cost of production will increase, SRAS will decrease

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47
Q

what happens if FOPs decrease

A

cost of production will decrease and SRAS will increase

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48
Q

what happens if indirect taxes or subsidies decrease

A

cost of production will increase

SRAS will decrease

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49
Q

what happens if indirect taxes decrease and subsidies increase

A

cost of production will decrease and SRAS will increase and shift to the right

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50
Q

what are supply shocks

A

wars, terrorist attacks, natural disasters

negative, SRAS will derease

major technological advancement, positive supply shock, SRAS will increase

51
Q

what are the two types of long run aggregate supply

A

supply side economists

demand side economists

52
Q

what do the supply side economists believe

A

monetarists

‘supply creates its own demand’

they believe in the efficiency of market forces
they believe hat governments should not intervene but only creates the conditions for markets to operate freely and efficiently

53
Q

what do demand side economists believe

A

Keynesian school of though

demand create its own supply

governments should intervene in the allocation of resources in the economy to affect AD and smooth out short term fluctuations

54
Q

monetarists supply side LRAS curve

A

vertical line at the level of potential output (full employment_ Yfe. because AS in the long run is independent of the price level

55
Q

what does the monetarists LRAS curve represent

A

represents the potential output that could be produced if the economy were operating at full capacity

full employment does not mean there is zero unemployment

wages and prices are fully flexible and will adjust freely

any attempt to change AD will only affect the price level and not on the level of real `GDP

asserts that the potential output is based solely on the quantity and quality of the factors of production and not on the price level

56
Q

what does the Keynesian LRAS look like

A

the curve haas three sections because of wage/price downward inflexibility and different levels of spare capacity in the economy

57
Q

what does section one of the Keynesian model show

A

does not distinguish between short run and long run only AS

the AS curve is perfectly elastic at low levels of economic activity because of wages/prices downward inflexibility (people will not accept cuts)

producers in the economy can raise their levels of output without incurring higher average costs because of spare capacity

there are high levels of unused factors such as unemployment and under used capital

should there be a greater need for output, these can be used to their fullest capacity at constant average costs.

58
Q

what happens in section two of the Keynesian model

A

much less spare capacity

economy is approaching full em0ployment

if firms want to increase aggregate supply, they have to bid for scarcer resources and so the cost of production will begin to rise

firms will pass these higher costs on to consumers in the form of higher prices

59
Q

what happens in section three of the Keynesian model

A

economy has reached its productive capacity - no more spare capacity - prosecuting at full employment level of output Yfe

Any further increase in AD will only lead to inflation and a rise in the average price level

60
Q

what factors shift LRAS

A

changes in quantity and or the quality of factors of production

- improvements in efficiency 
new technology 
reductions in unemployment 
institutional changes
investments in infrastructure 
discovery of new natural resources 
larger workforce 
improvements in education, training and work practices
61
Q

what is the Keynesian mode known to be

A

sticky wage model

62
Q

what is the new classical known to be

A

flexible wage model

63
Q

how do shifts in LRAS occur

A

caused by changes in the quality and quantity fo FOPS, therefore changes the productive capacity and productive output of the economy as a whole

similar to shifts in the PPC

64
Q

what are supply side policies

A

government policies aimed to increase the quantity of FOPS and or improve the quality of GFOPS, increases the proactive capacity

65
Q

what are the two types of supply side policy

A

interventionist and market - based

66
Q

what is the interventionist policy

A

based on the ideas that the government has a fundamental role to play in actively encouraging economizing economic growth

67
Q

examples of interventionist policies

A

investment in human capital, infrastructure, technology

industrial policies that promote growth like tax cuts and subsidization

68
Q

what is a market based policy

A

they focus on allowing markets to operate more freely with minimal government intervention . these may also be described as insertional changes as they affect the structure, institutions and rules that govern economic stakeholders

69
Q

what are examples of market based

A

policies to encourage competition
larbour market reforms
incentive related policies to increase workers incentive to work

70
Q

what is the aim of supply side policies

A

they aim to positive ely affect the production side of an economy by improving the institutional framework and the capacity to product therefore shift LRAS curve to the right

71
Q

factors to consider when evaluating supply side policies

A

time lags

ability to create employment

ability to reduce inflationary pressure

the impact on economic growth ,

impact on government budget

effect on equity

effect on the environment

72
Q

what does the SRAS represent

A

the output produced by the economy - it is equal to AD and the economy is also at its full employment level of output. Because AS is equal to AS, there is no upward or downward pressure on the price level, thus, there is no inflationary or deflationary pressure.

73
Q

what happens if there is an initial change such as AD increasing

A

could be caused by the government cutting taxes and increases government spending

AD will shift to the right

economy will experience a temporary inflationary gap where the output goes beyond Yfe and the average price level begins to rise, there is a short run equilibrium but a long run disequilibrium

in the long run, because of the rise in average price level, the costs of production will begin to rise and SRAS will shift to the left, bringing the economy back to full employment level of output at Yfe but with an even higher price level of P3

74
Q

what happens if there is an initial change of AD decreasing

A

could be due to consumer drop in confidence

Ad curve shifts left , average price level beings to fall and economy experiences a deflationary gap where actual output Y2 is less than potential output Yfe

in the long run, due to the fall in average price level, the costs of production begins to fall and so SRAS increases to SRAS1, bringing economy back to full employment levels of output Yfe at one even lower price level

75
Q

what do new classical economists argue

A

that the economy will always move automatically to its long run equilibrium - without any government intervention

while there may be short-term fluctuations in output, the economy will always return to the full employment level of output in the long run

they believe that shifts in the LRAs will change the long run equilibrium and change the full employment level of output.

shifts in the LRAs represent shifts in the economies productive capacity and can only occur in the long run and only due to changes in the quantity or the quality of FOPs

76
Q

when can the economy be at an equilibrium in the keynesian model

A

at any level of real output where AD intersects AS

77
Q

what do you say if the output is less than the full level of output

A

there is a recessionary gap

78
Q

what do keynesian believe about recessionary gaps

A

they belie that economy can remain stuck in this deflationary gap because the economy is still at equilibrium and it wont necessarily self correct or move automatically towards full employment level of output.

79
Q

what are the implications about Keynesians believing that the economy can remain stuck in a deflationary gap

A

government needs to intervene and use demand side policies to increase AD and close this deflationary gap by pushing output closer to full employment levels (Yfe). Also due to the existence of spare capactiy in the economy, producers can employ unused FOPs to increase output with no increase in costs - no inflationary pressure

80
Q

what happens if the real output is very close to full employment

A

there is an inflationary gap as any further attempts to increase AD from AD1 to AD2 will then be inflationary because the economy is approaching full employment and there is less spare capactiy - so to increase output producers must compete for scarcer resources and hence costs of production rises - rising average price level

81
Q

what is a demand side policy

A

policies used to influence the level of aggregate demand

can either be fiscal policies or monetary policies

82
Q

two types of demand side policies

A

fiscal and monetary policies

83
Q

what is a fiscal policy

A

use of taxes and government spending to influence the AD

84
Q

what is a monetary policy

A

use of interest rates and supply of money to influence the level of AD

85
Q

what is the aim of an expansionary policy

A

to increase AD and lower unemployment and encourage economic growth

86
Q

what is the aim of contractionary policies

A

to decrease AD and slow down the rate of inflation

87
Q

what do changes in LRAS have on the keynesian model

A

if LRAS increases - the impact of the economy will depend on the initial equilibrium

if operating below full employment level of output, then an increase in LRAS will have no effect on equilibrium output

if operating close to or at full employment level of output, then an increase in LRAS will help reign in the inflationary pressures of being close to or at full employment

88
Q

What is MPS

A

the marginal propensity to save

89
Q

what does MPS mean

A

the proportion of an increase in income that will be saved (leakage)

90
Q

what is MPM

A

the marginal propsentiy to import

91
Q

what does MPM mean

A

the proportion of an increase in income hat will be spend on imports (leakages)

92
Q

what is MRT

A

marginal rate of taxation

93
Q

what does the MRT mean

A

the proportion of an increase in income that will be taxed

94
Q

what is the MPW

A

marginal propensity to withdraw

95
Q

how is MPW measured

A

the sum of MPS, MPM and MRT

96
Q

what is the MPC

A

change in the consumption spending as a result of a change in income

97
Q

how to calculate MPC

A

1 - MPW

1 - (MPS + MPM + MRT)

98
Q

MPC + MPS + MPM + MRT =

A

1

99
Q

what is the keynesian multiplier

A

1 / 1 - MPC

100
Q

what is the multiplier effect

A

if a government decides to fill a deflationary gap by increasing its own spending, the final increase in AD will actually be greater than the amount of spending

will result in a proportionately larger increase in national income

101
Q

What is aggregate demand

A

the total spending on goods and services in an economy at a given price level over a period of time

Conumsption
Investment
Government spending
Exports - imports

102
Q

Draw aggregate demand curve

A

powerpoint

103
Q

What is consumption

A

the total sending by consumers on domestic goods and services

104
Q

What can consumption take place on

A

durable and non-durable goods

105
Q

What are durable goods

A

goods that are used over a long period of time (cars)

106
Q

What are non durable goods

A

goods that are used up immediately on in a short period of time

food, toilet paper

107
Q

What are non price determinants of consumption

A

Changes in income
changes in wealth
changes in consumer confidence
changes in interest rates

108
Q

Explain three factors that could cause a decrease in consumption in an economy (10 marks)

A

Definiton

diagram
factor 1
factor 2
factor 3

109
Q

What is government spending

A

money spent by governments at a variety fo levels on a wide variety of goods and services

110
Q

What factors affect government spending

A

objectives/policies eg austerity measures
business cycle
unexpected events

111
Q

What is investment

A

investment is the additional spending on capital stock by businesses

Capital stock includes factories, machines, offices and computers

112
Q

What are the two types of investment

A 
replacement investment (existing capital )
induced investment (new capital)
113
Q

What factors affect investment

A

interest rates
income
technological change
business confidence

114
Q

Draw a diagram for investment and interest rates

A

as investment goes up, interest rates go down

115
Q

What are net exports

A

exports - imports

116
Q

What are exports

A

the total value of goods and services that are bought by foreigners.

117
Q

What are imports

A

the total value of goods and services bought from foreign countries

118
Q

What factors affect net exports

A 
change rates 
domestic national income 
foreign national income 
trade policies
inflation
119
Q

What is aggregate supply

A

the total amount of goods and services industries will produce at any given price level

120
Q

What is long run aggregate supply

A

the period of time where the rices of the factors of production are variable, there are two theories about the LRAS curve

121
Q

What do new classical ‘monetarists’ believe abotu LRAS

A

Supply side economists believe that

  • there should be the very minimum amount of government intervention to allocate resources efficiently
  • supply side factors are more influential at decreasing unemployment
122
Q

What is the new classical LRAS like

A

LRAS curve is perfectly inelastic
represents potential output if economy was operating at full capacity
Yf is the full employment level of output
Price has no influence over quantity supplied
Potential output Is based on quality and quantity of factors of production
any deviation from this line is temporary

123
Q

What are the three phases of Keynesian AS

A

no difference between long run and short run

  1. perfectly elastic - firms can use spare capacity to increase output without increasing price levels
  2. Spare capacity is used up - higher prices are needed to cover higher costs for scarce resources
  3. perfectly inelastic - all factors of production are being used, increase in price does not affect output
124
Q

With the help of diagrams explain the difference between the Keynesian LRAS and the New classical LRAS (10 marks)

A

Plan

Economics (35 decks)

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