Aggregate Demand

Question 1

What are the most commonly used measures for income (or output) ?

Answer 1

GNP and GDP

Question 2

What determines the level of output (income) in an economy ?

Answer 2

The equilibrium level of income (output) (which we will denote by Y) is determined by the intersection of Aggregate Demand (AD) and Aggregate Supply (AS) curves.

Question 3

What is price level ?

Answer 3

Price level is an average of the prices of all goods and services produced in the economy and is also called the **general price level. **

Question 4

What are the two common indexes that are used to measure the overall level of prices by economists?

Answer 4

• GDP deflator
• consumer price index (CPI).

Question 5

What is the Consumer Price Index ?

Answer 5

(CPI) is a measure of the overall cost of the goods and services bought by a typical consumer.

Question 6

What are the two important differences between GDP deflator and the consumer price index ?

Answer 6

• The GDP deflator reflects the prices of all goods and services produced domestically, whereas the consumer price index reflects the prices of all goods and services bought by consumers.
• The consumer price index compares the price of a fixed basket of goods and services to the price of the basket in the base year. By contrast, the GDP deflator compares the price of currently produced goods and services to the price of the same goods and services in the base year. Thus, the group of goods and services used to compute the GDP deflator changes automatically over time.

Question 7

The goods and services produced in an economy are demanded by which economic groups ?

Answer 7

a) Households: The goods and services demanded by the households are called consumption goods. (C) is the biggest component of aggregate demand.
b) Firms: Firms demand goods and services for investment purposes. By investment we mean additions to physical capital stock. (I)
c) Government: government purchases (G) are part of aggregate expenditure.
d) Exports (EX) Imports (IM) NX

Question 8

What is Disposable Income?

Answer 8

Difference between income and taxes.

Disposable Income= Income(Y) - Taxes (T)

Question 9

What is Aggregate Demand (AD) ?

Answer 9

AD= C+I+G+NX

Question 10

What does The AD curve show ?

Answer 10

The AD curve shows the relationship between the output (Y) demanded and the price level (P) in the economy.

INVERSE RELATIONSHIP

Question 11

How does a change in the price level (P) affect the investment expenditure (I)

Answer 11

P+⇒M^d+⇒r+⇒I- ⇒AD-

Question 12

The AD curve shifts due to which 3 causes ?

Answer 12

1) Changes in government spending (G) (Fiscal policy)
2) Changes in taxation (T) (Fiscal policy)
3) Changes in money supply (Ms) (Monetary policy)

Question 13

Changes in Consumption affects AD as?

Answer 13

P - ⇒real wealth +⇒C+⇒AD+

Question 14

Changes in net exports effects AD as?

Answer 14

P+⇒NX-⇒AD-

Question 15

What are basic tools of Fiscal Policy ?

Answer 15

Government expenditure (G) and taxes (T) are the basic tools of fiscal policy

AD+ icin G+ or T-

Question 16

What is expansionary economic policy ?

Answer 16

An economic policy is said to be expansionary if it causes output (income) to increase.

When government increases its expenditures (G) or lowers taxes (T) , the aggregate demand increases even though the price level is unchanged

Question 17

What about a contractionary fiscal policy

Answer 17

An economic policy is said to be contractionary if it causes the income (output) level to fall.

G- ,T+

Question 18

Monetary Policy

Answer 18

money supply (Ms) shifts the AD curve

Question 19

What does expansionary monetary policy do ?

Answer 19

if the CB increases the money supply (expansionary monetary policy), the result is a fall in the interest rate Lower interest rate stimulates investment expenditure and AD increases as a result.

Question 20

What does contractionary monetary policy do?

Answer 20

(Ms - ), the fall in the money supply causes the interest rate to rise which in turn leads to a fall in the investment expenditure. This leads to a fall in aggregate demand at the initial price level P0.