Aggregate Demand and Aggregate Supply Flashcards
What is the circular flow of income
A model that describes the relationships between the total flow of income output and expenditures in an economy
- shows level of economic activity
What is a leakage and what are the three types of?
A leakage is when money flows out of the circular flow of income.
Savings Taxes and Imports
What is an injection and what are three types of?
An injection is when money flows into the circular flow of income.
Investment Government and Exports
What are the main assumptions of the circular flow of income?
- households and firms spend all of their revenue and income and don’t save
- closed economy (no foreign trade)
- no government ( no taxes)
What are the three ways of measuring GDP?
Expenditure Method
Income Method
Output Method
O=E=Y
What is the expenditure method of measuring GDP?
The expenditure method measures the total expenditure on a country’s goods and services in a year using C+I+ G +(X-M)
What is the output method of measuring GDP?
The final value of all goods and services produced in an economy in a year
What is the income method of measuring GDP?
Adding up all the factor incomes earnt in an economy in a year ( wages, interest, rent and profit)
What is aggregate demand?
The total demand for a country’s goods and services at a given price level in a given time period.
(It is a measure of spending not quantities)
What are the components of AD
C+I + G+(X-M)
Consumer spending, investment, government spending, exports and imports
What are the 3 effects that link to now changes in price level can effect the components of AD
1) wealth effect
2) trade effect
3) interest effect
What is the wealth effect?
The wealth effect states that as the price level decreases the purchasing power of income increases
- (people are richer and more likely to spend money on goods and services)
What is the trade effect?
The trade effect states that as price level decreases exports become more competitive and imports become less competitive
What is the rate of interest effect
High interests rate make it more expensive for people to borrow so demand will decrease
What is consumption?
The total spending by households on goods and services in an economy
(Accounts for 66% of AD)
When to use MPC?
When writing chains of analysis about the different determinants of consumption
What is the marginal propensity to consume
The willingness of a household to spend any extra income that they earn
What are the determinants of consumption
1)level of real disposable income
2) interest rates
3) consumer confidence
4) asset prices
5) household indebtedness
What affects consumer confidence?
Job prospects and level of unemployment
What is the consumption function?
The relationship between consumer expenditure and disposable income
What 7 things influence how much households spend
Real disposable income
Wealth
Consumer confidence
Rate of interest
Age structure of pop
Distribution of income
Inflation
What is investment
Spending by firms on capital goods or any man made aid to production which adds to capital stock
What is gross investment
Total capital spending
What is net investment
Total capital spending - capital consumption ( replacement investment )
Benefits of investment
Leads to an increase in the productive capacity by inc level of capital stock
Influences on investment
Rate of interest - low rates means cheaper to borrow and invest
Current profit levels
Expectations
Changes in real disposable income
Advances in technology
Influences on government spending
Level of market failure
Level of economic activity
Gov spending is mainly autonomous
What are imports
The purchase of goods and services from abroad that leads to an outflow of currency from the uk
What are exports
The sale of goods and services to buyers from other countries leading to an inflow of currency to the uk
Factors that influence the level of imports and exports
Real disposable income at home
Real disposable income abroad
Domestic price level relative to price level abroad - high inflation means exports fall imports rise
Exchange rate - stronger pound means cheaper imports
Gov restrictions on free trade - tariffs
What is aggregate supply
The total amount the producers in an economy are willing and able to produce at a given price level at a given time period
What does total quantity supplied in an economy depend on?
The quantities of inputs of factors of production
What is short run aggregate supply
When the prices of the factors of production are assumed not to be changing
- refers to the total production of goods and services available in an economy at different price levels while some production factors and resources are fixed
What factors shift the SRAS curve
Change in costs
Taxes
What is supply side shock
A large change in raw material costs , wage rates , taxation that can have a significant impact on SRAS
What is supply side shock
A large change in raw material costs , wage rates , taxation that can have a significant impact on SRAS
Examples of external supply shocks
World oil and gas prices
Energy prices
Foodstuff prices
Import tariffs
What is LRAS
All factors of production are variable
- determined by all factors of production
- represents the total possible level of real output
What is the neo-classical / monetarist view of LRAS
STRAIGHT LINE
- the economy would always find its way to overall equilibrium which corresponds to a situation in which the economy is at full employment
- the LRAS is not sensitive to changes in the price level
What is the Keynesian view of the LRAS
- macroeconomy is not sufficiently flexible enough to enable continuous full employment
What causes a shift in the LRAS curve ?
A change in the quality or quantity of factors of production over time
- these changes bring about changes in the productive potential of the economy
What would increase quantity of each factor of production
Labour - increase in size of workforce due to migration
Land -
Capital - level of investment,
Enterprise -
What is macroeconomic equilibrium
A state of national economic activity wherein aggregate demand is equal to aggregate supply
What are assumptions of the Keynesian model
- wages are sticky downwards amid workers will not readily and quickly accept pay cuts
- therefore recession in the long run can be caused by insufficient AD
Assumptions of the classical model
All markers are competitive
The economy will always quickly adjust to equilibrium
Owners of factors of production will act rationally
What the is the National income - multiplier
The process by which any change in a component of AD results in a greater final change in real GDP
Outline a key multiplier example
- gov increase spending by 1billion for new homes
- generate income for households
- builders will spend some of this extra income earned
- this spent income generates income for shopkeepers
Therefore original increase in gov slenjmg sparks off further income generation and spending
Side of mulitplier effect depends on…..
How much additional income is saved, returned through taxes and spent on imports
Calculation for average propensity to save
S/Y
Calculation for APT
T/Y
Calaculation for APM
M/Y
Calculation for APW
W/Y
Calculation for APW
W/Y
Calculation for MPC
change in C / change in Y
Calculation for MPC
change in C / change in Y
Calculation for MPW
change in W/ change in Y
What always equals 1.0
MPC + MPW
Formula for calculating the multiplier
K = 1 / MPW ( MPS + MPT + MPM)
Formula for calculating the multiplier
K = 1 / MPW ( MPS + MPT + MPM)
What is the accelerator theory
The accelerator effect happens when an increase in national income (GDP) results in a proportionally larger rise in capital investment spending
- higher proportion of investment spending than demand
How do the multiplier and accelerator interact
