Aggregate Demand / Aggregate Supply

Question 1

Why does National output = National Income = National Expenditure ?

Answer 1

Firms produce goods and services which make up national output.
Households provide factors of production (ie. labour +capital) to produced national output. In return they recieve money, ie. National Income.
Households then spend this money on goods and services that firms create - making up national expenditure

National output = National Income = National Expenditure

Question 2

Physical vs Monetary Flows

Answer 2

Physical flows refer to the transfer of ‘real things’, eg. goods, services, labour, land and capital

Monetary flows refers to the transfer of money to pay for the ‘physical things’.

Question 3

Injections / Withdrawals from the Circular Flow

Answer 3

Injections into the circular flow inlcude; 1. Exports, 2. Govt. Spending + 3. Investment

Withdrawals from the circular flow include; 1. Imports, 2. Savings + 3. Taxation

Question 4

Equilibrium in the Circular flow

Answer 4

When Injections = Withdrawals, the CFI is in equilibrium

Question 5

Multiplier Effect (definition)

Answer 5

When an injection into the CFI leads to a proportionally greater increase in national income.

Question 6

Size of the multiplier

Answer 6

The value of the multiplier depends upon the percentage of extra money that is spent on the domestic economy. ie. MPC vs MPS

Question 7

Components of AD

Answer 7

Consumption (c. 65% of AD)
Investment
Govt. Spending
Trade Balance (Exports - Imports)

AD = C + I + G + (X - M)

Question 8

Factors which affect Consumption vs Savings

Answer 8

Income - As disposable income rises, consumption will increase and Savings will likely also increase.

Interest Rates - High interest rates provide an incentive to save, consequently reducing the MPC.

Confidence - When consumer confidence is low, they tend to save, and visa versa

Wealth effects - If the price of consumers’ assets increases, consumption will likely increase due to greater confidence

Taxes - Direct taxes reduce disposable income +/or Indirect tax increases the cost of spending , and therefore reduce consumption.

Unemployment - A fall in unemployment increases households’ disposable incomes, facilitating higher levels of consumption + saving.

Question 9

Gross vs Net Investment

Answer 9

Gross investment = all investment spending
Net investment = investment spending which has increased the productive capacity.

ie. replacing 3 old vans with 5 new ones, gross investment = 5 vans, net investment = 2 vans.

Question 10

Factors which influence investment

Answer 10

Risk - The level of risk will affect the quantity of investment, eg. during periods of economic instability.

Govt. Incentives / Regulation - Eg. Corporation Tax cuts can incentivise investment. Relaxation of regulation may promote investment.

Interest Rates / Credit Access - When interest rates are high, so is the cost of borrowing, therefore discouraging investment.

Technical Advancements - Firms may need to invest in new technology in order to remain competitive

Business Confidence - If business confidence is high, ie. during a boom, then investment is likely

Question 11

Animal Spirits

Answer 11

John Keynes -

Not all investments are made in regards to confidence.
Human emotion, Intuition and ‘gut instinct’ are all important factors in making investment decisions.

Question 12

Features of Govt. Spending

Answer 12

Only money that directly contributes to the output of the economy is included in the AD calculation - ie. not transfer payments (JSA / Pensions)

Govt. spending is a large part of AD.

Govt. spending does not often = the budget / revenue.

Question 13

Exchange Rates on (X-M)

Answer 13

Long-Run = If the value of currency increases, imports become cheaper (SPICED), constituting a worsening net exports.

Short-Run = Import / Export demand is relatively inelastic. Therefore, in the short-run, the yield on exports will increase and cost of imports reduces - leading to an improving net exports.

Question 14

Factors which influence (X-M)

Answer 14

World Economy - Fluctuations in supply and demand in foriegn contries will affect the UK’s trade balance.

Protectionism - Tariffs + Quotas affect the international competitiveness of goods and services

Non-Price Factors - Higher quality products will be demanded more, alterning net exports.

Question 15

Causes of AD shifts

Answer 15

Aggregate demand will shift if any changes occur to the components of AD.

Eg.
Tax changes
Interest rate changes
NMW
Confidence
Technology
Economic Growth
Infrastucture changes
Global Economy changes
Exchange Rates

Question 16

Average Propensities

Answer 16

The APS / APC can be used to understand what is being done with national income

APC = Consumption / Total Income

APS = Quantity Saved / Total Income

Question 17

Marginal Propensities

Answer 17

MPC is the proportion of additional income that is spent on consumption

MPS is the proportion of additional income that is saved

MPC = change in C / change in Y

MPS = change in S / change in Y

Question 18

Marginal Propsensity + Size of the Mulitplier

Answer 18

If MPC is low, the size of the multiplier will be small. ie. lots of the additional income is being saved.

If MPC is high, the size of the multiplier will be large. ie. not much additional income is being saved

Question 19

Multiplier Effect formula

Answer 19

Multiplier = 1/ (1-MPC)

Question 20

Aggregate Supply

Answer 20

The total output produced by an economy at a given price level over a given time period.

Question 21

SRAS vs LRAS

Answer 21

Short-run = Used to illustrate a firm’s current willingness + ability to produce goods / services over a range of prices.

Long-run = Where the economy is at full capacity, ie. all factors of production are fully utilised.

Question 22

Causes of SRAS shifts

Answer 22

SRAS will shift when the costs of production changes.

eg.
Raw Material Costs
Taxes
Tariffs
Wage Rates / NMW
Supply-side shocks

Question 23

Causes of LRAS shifts

Answer 23

LRAS will shift if there’s a change in the factors of production which affects the capacity of the economy.

eg.
R+D
Investment
Education / Training
Migration
Supply of Raw materials
Healthcare changes
Regulation changes
Market Liberalisation / Competition
Promotion of enterprise
Factor mobility

Question 24

Role of Banks with LRAS

Answer 24

Firms will borrow from banks in order to invest (eg. into new capital) and increase their productive capacity.

If a nation has a strong banking system, then they will aid economic growth.

Question 25

Accelerator Effect

Answer 25

It assumes that investment levels and the rate of economic growth are closely related.

Ie. When national income is growing rapidly, businesses will invest heavily.

This occurs as firms expect the strong economic growth to be sustained and make future profits from capital investment.

Common during Recovery or Early boom.

Question 26

Keynsian LRAS

Answer 26

At low levels of output, AS is elastic as there is lots of spare capacity and output increases will not cause increased price levels.

As output increases, the LRAS curve begins to slope upwards as firms face supply bottlenecks, ie. problems with obtaining labour / resources, increasing price levels.

The curve then becomes completely inelastic as the economy reaches full capacity and all resources are being fully utilised.