4.2.2.2 aggregate demand and aggregate supply analysis

Question 1

what is aggregate demand?

Answer 1

total spending of goods and services in an economy over a period of time

Question 2

what does the AD curve look like?

Answer 2

Question 3

why is the AD curve downward sloping?

Answer 3

• at higher prices (inflation levels), total demand decreases
  -> fall in the value of real incomes
  -> good and services become less affordable in real terms
• as P level increases, UK goods become less competitive
  -> = decrease in X, increase in M (international effect)
  -> deficit on the current account might fall
  -> foreign goods seem relatively cheaper
• Real Balance Effect
• Interest Rate

Question 4

what do changes in price level lead to on the AD curve?

Answer 4

movements ALONG the AD curve

Question 5

what causes a shift in the AD curve?

Answer 5

• changes in the components of AD
• an increase is shown: shift from AD1 to AD2
• decrease is shown: shift from AD2 to AD1

Question 6

why would AD shift outwards - to the right?

Answer 6

= a rise in economic growth

• consumers and firms have higher confidence levels
  -> they invest and spend more
  -> feel they’ll get a higher return on them
  -> affected by anticipated income and inflation
• lower interest rates
  -> cheaper to borrow
  -> reduces incentive to save
  -> spending and investment increase
  —> there are time lags between the change in interest rates and the rise in AD, so this isn’t suitable if a rise in AD is needed immediately
• lower taxes
  -> gov has more disposable income
  -> increases AD
• increase in gov spending
  -> increases AD
• depreciation in a currency means M is more expensive and X is cheaper
  -> AD increases

Question 7

what does aggregate supply show?

Answer 7

• the quantity of real GDP which is supplied at different price levels in the economy

Question 8

why is the AS curve sloped upward?

Answer 8

because at a higher price level, producers are willing to supply more because they can earn more profits

Question 9

what leads to movements along the AS curve?

Answer 9

only changes in price level which occur due to changes in AD lead to this

Question 10

what happens in the SRAS (this is AS) if AD increases / falls?

Answer 10

increases
- expansion in the SRAS from Y1 to Y2 (right)

decreases
contraction in SRAS from Y1 to Y3 (left)

Question 11

what causes a shift in the SRAS (this is AS) curve?

Answer 11

• shifts when there are changes in the conditions of supply
• cost of employment might change
  -> wages / taxes / labour productivity
• cost of other inputs
  -> raw materials / commodity prices / exchange rate if products are imported
• gov regulation or intervention
  -> environmental laws / taxes / business regulation

Question 12

what does the SRAS cover?

Answer 12

the period of time immediately after a change in the price level

Question 13

what does the SRAS show?

Answer 13

the planned output of an economy when prices change
whilst the cost of production and productivity of the factor inputs are kept constant

Question 14

what does the LRAS show?

Answer 14

• the potential supply of an economy in the long run
  -> this is when prices, costs and productivity of factor inputs, can change
• can show the economy’s productive potential

Question 15

why is the LRAS curve vertical?
which way does it shift with economic growth?
what is long run growth?

Answer 15

because supply isn’t assumed to change as the price level changes

rightwards (outward shift of the production possibility curve)
it enables more output to be produced with the existing stock of resources

Question 16

what does the LRAS represent?

Answer 16

• the max amount an economy can produce
• represents the normal capacity output level for the economy

Question 17

what does the equilibrium position give us?

Answer 17

-provides info about current economic performance

• shows the real level of national income and price level
• from this, further assessments can be made about progress towards the governments economic objectives:

-> economic growth
- measured as the change in RNI
-> employment
- ↑ real GDP means output levels are rising
- this means demand for workers to produce that output will ↑
- unemployment falls
-> inflation
- changes in price level reveal this

Question 18

when does LRAS equilibrium occur?

Answer 18

where AD intersects with LRAS

always occurs at the max output level for an economy

Question 19

what do increases in AD cause the equilibrium position?

Answer 19

moves upwards along the LRAS curve with no increase in real output

Question 20

what’s the effect of higher AD in the long run?

Answer 20

higher price level
ie. inflation

Question 21

what does a demand-side shock affect?

Answer 21

the level of national income, unemployment and inflation

eg) banking crisis 2008 - affected businesses and consumer confidence
unexpectedly large change in the exchange rate / interest rate

Question 22

what does a supply-side shock do?

Answer 22

will have a knock-on effect on the willingness of firms to produce output
will lead to large changes in the level of aggregate supply

eg) changes in commodity prices
significant crop failure in an important product
conflict in a country that produces a vital input, which limits its availibility

Question 23

which economic shock is worse?

Answer 23

supply-side shocks often have more negative consequences than demand-side shocks

likely to be both inflation and higher unemployment if there’s a sharp reduction in AS

demand-side shock will often only affect either unemployment or inflation, but not both

Question 24

what happens to supply and demand at price above and below equilibrium?

Answer 24

above equilibrium
- excess supply

below equilibrium
- excess aggregate demand in the short run

Question 25

define:
- short-run growth
- long-run growth

Answer 25

short-run
- the actual annual percentage change in real national output

long-run
- an increase in the potential productive capacity of the economy