Aggregate demand and supply analysis Flashcards
What is aggregate demand?
The total level of spending in the economy Consumer spending+ Investment+ government spending +(Exports-Imports)
Why is the Aggregate demand curve downward sloping?
1) The lower the level of inflation the cheaper goods will be to buy, real incomes will be higher so real GDP will increase 2)The lower our inflation is the more competitive our economy is so the more exports bought and imports less bought and so net exports increases.
What will the effects of a change in aggregate supply largely depend on?
The previous position of the economy, EG- If the economy is in recession an increase (outwards shift) in the LRAS curve is likely to have no real effect on the economy, it will only make the output gap bigger. This is because businesses only produce what they think they can sell.
In terms of PPF this shifts the PPF outwards but our current position remains inside it.
What is the effect of an increase in investment spending?
Both AD and LRAS will increase. AD: Investment is part of what calculates AD LRAS: With better equipment form the investment they can produce more. The actual effects of this depend on the previous position of the economy.
What are the 3 main factors that effect the impact an increase in AD will have on the economy?
1) The size of the increase, the bigger the increase the bigger the impact 2) The previous position of the economy 3) The size of the multiplier effect. I.E- If the government spends more money in the economy that creates more jobs for other people, their income rises which means they can afford to spend more themselves thus increasing AD.
What are the 2 main differences between the Keynesian and monetarist views of AD and AS?
1) Monetarists believe that in the long run the economy naturally tends to its full employment position. Therefore in the long run the economy will always produce at its maximum output, therefore they believe that the LRAS curve is vertical at the full employment position. 2)Monetarists distinguish between a short run and long run Aggregate supply curve this SRAS explains why in the short run output might even be less or greater than its full employment position. The SRAS curve will be upward sloping, this means that the more businesses produce the more expensive it’ll be to produce the extra output.
What assumptions are made when using the SRAS curve? and Why do monetarists think that costs will increase as a business produces more?
The SRAS curve is produced on the assumption that wages and the prices of all other resources bought remain constant (the same) Costs will increase with production because: 1) If businesses want to produce more they may have to pay them overtime which is usually a bit more expensive. 2) If they want to produce more (particularly when the economy is close to full employment) businesses will have to employ people of lower skill, their productivity will be lower and they may have to spend more money on training, this increases costs.
What causes a shift in the ‘Short Run Aggregate Supply Curve’? (SRAS)
A change in wages or the prices of other resources businesses have to buy. A reduction will shift the SRAS curve outward/right An increase will shift the SRAS curve Inwards/left This is due to the amount that businesses can afford to produce with the costs they have, of course this still depends on the previous position of the economy (if the economy is in a recession they still may not decide to produce more if costs decrease).
How does a fall in AD affect the SRAS, infaltion and real output?
What is the effect of a fall in short run costs on the SRAS curve?
NAme 2 other changes which might cause both the AD and short run aggregate supply curves to change?
- Changes in interest rates: E.g- a fall in interest rates leads to AD increasing due to both consumers and businesses increasing their spending. AS will also increase because businesses are investing more in new machinery which will make them more productive
- Changes in income tax: E.g- An increase in income tax leads to a fall in AD as people have less disposable income, might also reduce AS as peope will have less incentive to work.
In both cases although they’re happening in the same time period AD will have an effect before AS.
