4.2.2.4_-_Aggregate_demand_and_the_level_of_economic_activity Flashcards
What factors cause AD to influence the levels of economic activity?
- Employment: influences production and consumption - Confidence: influences the level of spending and investment
- Events: natural disasters or seasonal holidays influence the level of consumer spending
- Other factors: such as taxes and interest rates influence how much firms and consumers borrow, save or spend.
When does the multiplier effect occur?
When there is new demand in an economy
What does the multiplier effect occurring cause?
It leads to an injection of more income into the circular flow of income, which leads to economic growth. This means that more jobs are created, higher average incomes, more spending, and eventually, more national income is created
What is the multiplier effect?
The multiplier effect refers to how an initial increase in AD leads to an even bigger increase in national income. It is the idea that one person’s expenditure becomes someone else’s income, so the money goes round the circular flow multiple times until it is leaked out
What does the multiplier effect cause?
AD shifts even further to the right, the bigger the multiplier effect the bigger the shift.
What will the size of the multiplier depend on?
The size of the leakages from the circular flow of income, this is very difficult to measure in practice
Why is the size of the multiplier difficult to measure?
Partly due to the time lags, the multiplier effect can take years to fully show up in the economy. E.G. the full benefits to the economy of government spending on improving transport links may take years to appear
Partly due to the fact like everything in the economy its changing all the time
How does the multiplier effect impact governments?
It makes it very difficult for governments to accurately control AD
What happens with the multiplier effect when an economy has spare capacity
If an economy has a lot of spare capacity, SRAS is elastic, rising demand can be met easily i.e. extra output can be produced quickly and at little extra cost.
This means that the size of the multiplier will be larger. A small increase in AD will lead to a large increase in national income.
This makes, therefore little need for additional capital investment
What happens with the multiplier effect when an economy has no spare capacity?
SRAS is inelastic, the multiplier effect is likely to be smaller than its potential. This is because if AD increases, prices will increase rather than a full increase in national income.
This higher rate of inflation will lead to higher interest rates.
This will discourage spending and borrowing, and it will encourage saving, since the reward for saving is higher.
What is meant by the reverse multiplier effect?
It means that a withdrawal of income from the circular flow of income could lead to an even larger decrease in income for the economy. This could decrease economic growth and potentially lead to a decline in the economy
What is mpc?
A consumer’s marginal propensity to consume is how much a consumer changes their spending following a change in income
How does mpc relate to the multiplier effect?
The higher the MPC, the bigger the size of the multiplier.
How could the government influence mpc?
By changing the rate of direct tax. If consumers have more disposable income due to lower income tax rates, their propensity to consume might increase.
What is a consumers mps + mpc equal to?
1
