3.2 Aggregate Demand And Aggregate Supply Flashcards
What is aggregate demand
Total spending on goods and services within an economy over a particular time period
Determinants of aggregate demand
- consumption spending
- Investments
- government spending
- exports - imports
Causes of changes in consumption spending
- changes in consumer confidence — low consumer confidence indicates expectations of falling income and worsening of economic conditions, decreasing spending (AD shift left)
- changes in interest rates — increase in interest rates makes borrowing more expensive, lowering consumer spending (AD shift left)
- changes in wealth — increase in consumer wealth, makes people feel wealthier, increase in consumer spending (AD shift right)
- changes in income taxes — lower income tax, higher disposable income, higher consumer spending (AD shift right)
- changes in level of household indebtedness — if consumers have high debt, high pressure to make payments, cut back on spending (AD shift left)
- expectations of future price levels — if consumers expect prices to fall, they postpone spending, reducing consumer spending (AD shift left)
Causes of changes in investment spending
- changes in business confidence — high business confidence, more spending on investment (AD shift right)
- changes in interest rates — increase interest rates, increased cost of borrowing, reduced investment spending (AD shift left)
- changes in technology — improvements in technology stimulate investment spending (AD shift right)
- changes in business taxes — increase business taxes, profits fall, investment spending decreases (AD shift left)
- the level of corporate indebtedness — if firms have high levels of debt, willing to make less investments (AD shift left)
- legal changes
Causes of changes in government spending
- changes in political priorities — may decide to increase/decrease expenditure in response to changes in priority
- changes in economic priorities
Causes of changes in export - import spending
- changes in national income abroad
- changes in exchange rate
- change in trade policies
What is aggregate supply
Total quantity of good and services produced in an economy over a particular period of time
What is short tun aggregate supply
A period of time where prices of resources are roughly constant ; shows the relationship between the price level and the quantity of real output produced by firms when resource prices (especially wage) do not change
Factors that cause SRAS to shift
- changes in wages — of wages increase, production costs rise, leftward shift of SRAS
- changes in non-labour resource prices — Increase in price of a resource, increase production costs, leftward shift of SRAS
- changes in indirect taxes — higher indirect taxes, increase in production costs, leftward shift of SRAS
- changes in subsidies offered to businesses — if subsidies increase, lower production costs, SRAS shift right
- supply shocks — negative supply shocks e.x natural disasters, shift SRAS to left
2 ideas of long-run aggregate supply
Monetarist / new classical model
Keynesian model
Explain what the monetarist / new classical school believe + draw the graph
Believe LRAS curve is vertical at full employment level of output, indicating that in the long run the economy produces potential GDP , which is independent of the price level
In other words:
Often believe that there should be minimal governmental
intervention in markets, and with this idea, the LRAS curve is perfectly inelastic, meaning that there is the same demand at any price level.
The LRAS considers output to be entirely based on the quality and quantity of factors of production, and not price levels, so price levels
Why is LRAS curve vertical in monetarist model
As wages change to match output price changes, therefore firms costs of production remain constant even as the price level changes
What is a deflationary gap + draw graph for it
Situation where real GDP is less than potential GDP due to insufficient aggregate demand
What is an inflationary gap in monetarist model
Situation where real GDP is greater than potential GDP due to excess aggregate demand
What do the monetarists believe happens in the long run to the inflationary and deflationary gap
They are eliminated in the long run due to economy’s tendency towards full employment equilibrium
Explain what the Keynesian model beleive + draw the graph
Inflexible wages and prices in the downward direction mean economy cannot move into long run when experiencing a deflationary gap - one supply curve
Explain the three sections of the Keynesian AS curve
Section 1 - real GDP is low, price levels remain costar as real GDP increases — Lots of unemployment of resources and spare capacity — firms can easily increase output
Section 2 - real GDP increases followed by increases in price levels — no longer spare capacity in economy — wages and other resource prices rise, meaning so do production costs — firms sell at higher prices
Section 3 - AS curve becomes vertical — Real GDP reaches a level where it cannot increase anymore — this point price level increase rapidly, as firms are using maximum amount of labour and all other resources in an economy — any efforts on the part of firms to increase output results in increase in price levels
