4.3 Aggregate Demand and Aggregate Supply Analysis Flashcards
What is the definition for Aggregate Demand?
AD is the total demand in the economy from consumers, firms, governments and from abroad
How do we calculate AD?
AD = C+I+G+(X-M)
What does the C+I+G+(X-M) mean?
- C= Consumer spending by households on goods and services
- I= Investment spending by firms on capital equipment
- G= Government spending on provision of merit and public goods
- (X-M)= Net exports, the difference between revenue from exports and spending on imports
What are the main causes of shifts in the AD curve?
- Intrest Rates
- Exchange Rates
- Consumer Confidence
- Income Tax
- Tariffs
- Government Spending
Why does the AD curve slope downwards?
Because when the average price level in an economy rises(eg.Inflation) real GDP will fall.
What are the 3 reason to which why real GDP falls as price level rises in an economy?
- The Wealth Effect
- The Interest Rates Effect
- The Exchange Rates Effect
What is the definition for aggregate supply?
Aggregate Supply is the total production of goods and services in an economy at different price levels.
What causes a shift in the SRAS curve?
When there is a changes in costs of production in an economy.
What causes a shift in the LRAS curve?
When there is changes in the quantity/quality of factors of production in an economy,
When does a movement along the AD/AS curve occur and what typically causes this?
When there is a change in price level, typically caused by inflation and deflation
What does the new classical model assume?
- The economy automatically tends to move towards full employment in the long run.
- Wages are flexible and they change to match the change in price level.
What causes a recessionary gap?
Actual level of output is below the potential output.
What causes an inflationary gap?
Actual output is above the potential output.
What does Keynesian argue about the new classical model?
That wages aren’t adjustable mostly due to trade union powers and employment contracts.
In the Keynesian Model, at spare capacity, what happens to price level when real GDP increases or decreases?
At spare capacity, price level remains the same
In the Keynesian Model, at full capacity, what happens to real GDP as price level falls or increases?
At full capacity, real GDP remains the same.
What is the wealth effect?
When price level changes, consumption pattern change leading to lower or higher real GDP
Use the example of price level falling to explain the exchange rate effect
When our price level falls against others, there is more demand for our currency as people would have more purchasing power, leading to higher real GDP
Use the example of price level falling to explain the intrest rate effect
Banks will set intrest rates lower to mirror the price level, leading to higher consumption due to more borrowing
