Aggregate Demand and Supply Flashcards
What three key macroeconomic variables does the AD/AS model explain?
Changes in components of AE
Spending on output
the demand side of the economy
Define aggregate demand. What are the four elements of aggregate demand?
Aggregate demand is the total amount of demand for final goods and services in an economy at any point in time. Consumption, Investment, Net exports and government spending
How does an increase in the price level affect aggregate real income?
A rise in the price level reduces the purchasing power of household income or wealth
Why does a rise in the price level tend to increase interest rates?
A general rise in the price level means that households and firms will demand more funds to finance their transactions. The rising demand for money drives interest rate upwards, increasing the cost of borrowing and creating a disincentive to spend
Explain what is meant by the ‘open economy’ effect?
If the domestic price level rises relative to other countries, domestically produced goods and services become less competitive with those produced overseas, leading to a reduction in export revenue. At the same time a rise in the domestic price level will mean that consumers and business firms will purchase more goods and services from foreign producers, and less from domestic producers. An increase in price level, will decrease net exports
List two events that could lead to a rightward shift in the AD curve
If the government reduced income tax - disposable income will rise and household spending will tend to increase, shifting the AD curve to the right
An increase in government spending would shift the AD curve to the right
What effect would a stockmarket crash have on the AD curve?
When investment spending falls, AD shifts to the left
Explain the term aggregate supply
Aggregate supply is the total supply of goods and services produced within an economy at a given overall price in a given period.
Explain why the LRAS curve is vertical
Because it represents the maximum level of output at a particular point in time
Explain why the SRAS is upward sloping
Because it shows how an increase in economic activity increases the general price level
List two events that could lead to a leftward shift of the SRAS curve
Increasing world oil prices
Storms and droughts
Explain the difference between short run and long run macro equilibrium
The economy is said to be in short-run macro equilibrium when the AD and SRAS curves intersect. This is the economy’s actual level of production
The economy is said to be in long-run macro equilibrium when all three curves intersect. This means that actual output would equal potential output
What are contractionary and expansionary gaps?
A contractionary gap is when the AD and SRAS curve intersect to the left of the LRAS curve. The current equilibrium level of real GDP is less than potential
An expansionary gap is when the AD and SRAS curve intersect to the right of the LRAS curve. The current equilibrium level of real GDP is above potential
Explain how the economy will self-correct if actual GDP is less that potential
When actual GDP is below potential, the unemployment rate is above the natural rate. This should cause real wage increases to slow, shifting the SRAS to the right, moving the economy back towards potential GDP. Aggregate demand may start to rise as consumer and business confidence improves or as the government or Reserve Bank implement expansionary policies to encourage spending.
Explain why the LRAS curve typically shifts to the right over the time
Overtime, all of the curves tend to shift to the right due to economic growth. The population and labour force grow due to natural increase and migration. The capital stock, consisting of machinery, business equipment, new housing, factories and social infrastructure also grows as new projects and businesses are developed.
