Aggregate Demand And Supply

Question 1

What are the three leakages or withdrawals from the circular flow of income?

Answer 1

Savings, Tax and Imports.

Question 2

What are the three injections into the circular flow of income?

Answer 2

Investment, Government Spending and Exports.

Question 3

Define National Income.

Answer 3

National income is a flow of money, and is the amount received by various agents in the economy. It is the same as GDP and total spending by households, firms and government.

Question 4

What is income?

Answer 4

Money received from factors of production & work.

Question 5

What are the two exchanges in the circular flow of income?

Answer 5

Households and firms exchange consumer expenditure for goods and services, and factors of production for wages, rent and dividends.

Question 6

Define Aggregate Demand (AD).

Answer 6

Aggregate demand is the total amount of planned spending on goods and services at any price level in the economy.

Question 7

What are the three reasons the AD curve slopes downwards?

Answer 7

• The real balance effect: a decrease in price level increases the real value of money. The larger the quantity of real money, the larger the quantity of goods and services demanded.
• The international trade effect: if UK goods become cheaper then, ceteris paribus, UK citizens will buy more UK goods (fall in imports) and foreigners will buy more UK goods (an increase in exports).
• The substitution effect: for various reasons, a fall in the average price level means there are lower interest rates. This means there is a shift in aggregate demand from the future to the present, so increasing he quantity of goods demanded today.

Question 8

Define Wealth.

Answer 8

Wealth is a stock of assets, e.g. valuable factories.

Question 9

What are the components of AD?

Answer 9

AD = Consumption + Investment + Government Spending + ( Exports - Imports )

Question 10

Which component of AD is the largest component, and what percentage of AD does it make up?

Answer 10

Consumption is the largest component of AD, being worth 65% of AD.

Question 11

What are the main determinants of consumption?

Answer 11

• Interest rates.
• Consumer confidence.
• Wealth effects.
• The level of employment and wage rates.

Question 12

What are the main influences of Investment?

Answer 12

• Interest rates.
• Confidence levels.
• Risk.
• Government decisions.
• Government bureaucracy.

Question 13

Define Aggregate Supply.

Answer 13

Aggregate supply is the amount that all firms in the economy are willing to supply at various price levels.

Question 14

Describe the two approaches to aggregate supply.

Answer 14

The Keynesian approach to AS reflects the belief that an economy can be at equilibrium when there is spare capacity in the economy.
The classical approach to AS reflects the view that if there is spare capacity in the economy it cannot be said to be in equilibrium and eventually the spare capacity will disappear.

Question 15

Define spare capacity.

Answer 15

Spare capacity is where there are unemployed resources in an economy.

Question 16

Why does the AS curve shift?

Answer 16

• Changing costs in raw materials.
• Change in the level of international trade.
• Change in exchange rates.
• Technological advances.
• Relative productivity changes.
• Education skills changes.
• Regulation changes.
• Changes in the minimum wage.
• Changes in the tax and benefit system.

Question 17

What is the equilibrium point and what does it tell us?

Answer 17

The equilibrium point is where AS meets AD and there is no tendency to change. It tell us the price level and real GDP of a country.

Question 18

What is the multiplier?

Answer 18

The multiplier shows the amount by which a change in an injection or withdrawal causes total spending to change. It is the result of income being respect in an economy, having second and successive round effects.

Question 19

Define second round effects.

Answer 19

Changes when firms, individuals and governments respond to initial changes.

Question 20

What happens to the multiplier if injections increase?

Answer 20

If injections increase then there will be a larger final change on total spending in the economy.

Question 21

What happens to the multiplier if leakages increase?

Answer 21

If leakages increase then the multiplier effect will be smaller.