Aggregate Demand And Supply- Theme 2

Question 1

What are the components of aggregate demand?

Answer 1

Consumption (C), investment (I), government expenditure(G), and exports minus imports (X-M)

Question 2

What are the 3 ways to explain the downward sloping AD curve?

Answer 2

• lower prices in economy mean increased international competitiveness, so there are more exports and fewer imports.
• total amount of spending is approximately equal whether prices are high or low because people have approximately the same amount of money to spend, so area under curve is constant. This known as real balance effect.
• higher price levels interest rates likely to be raised by monetary authorities, means investment falls and savings might increase.

Question 3

What’s disposable incomes influence on consumer spending?

Answer 3

The higher the income after tax (disposable income) the more people are likely to spend, but might spend at a slower rate as they earn more.

Question 4

What’s the relationship between savings and consumption?

Answer 4

The more people feel they need to save the less they spend, so consumption decreases, and vice versa

Question 5

Explain interest rates influence on consumer spending.

Answer 5

Higher interest rates give people an incentive to save and increase cost of borrowing so spending decreases.

Question 6

Explain how consumer confidence influences consumer spending.

Answer 6

If consumers feeling confident they’re more likely to make large purchases that they can pay for in the future.

Question 7

Explain how the wealth effect influences consumer spending.

Answer 7

When house prices accelerate upwards, home owners can extract more equity from their houses so spending is increased.

Question 8

What’s the difference between gross investment and net investment.

Answer 8

Gross investment is total amount of investment before any account is taken of depreciation of assets. Net investment takes account of the fall in value of capital assets, more useful if want to look at productivity of economy and its productive potential.

Question 9

How do interest rates influence investment?

Answer 9

Inverse relationship between interest rates and level of inflation that firms intend to make. Because increases in capital stock have to be financed and there’s an opportunity cost to that finance. Firms often borrow from banks to finance investment, so if interest rates rise so does cost of borrowing and firms less likely to borrow and therefore less likely to invest.

Question 10

Define the trade cycle.

Answer 10

The pattern of economic growth which changes from booms to recessions or slow growth in a fairly regular pattern.

Question 11

How does the trade cycle influence government expenditure?

Answer 11

In boom or period of high economic growth, government expenditure is likely to fall as there’s less demand for Jobseeker’s allowance and other benefits to low income groups. Revenue from taxation likely to rise too, so government expected to be able to run a budget surplus during a boom.

Question 12

Define fiscal policy.

Answer 12

The deliberate manipulation of government spending and taxation in order to influence the level of AD in the economy.

Question 13

How does fiscal policy influence government expenditure?

Answer 13

Government can deliberately manipulate AD by overspending when there’s a slowdown in economy, and vice versa in a boom. Fiscal policy can be used to prevent bubbles in growth and markets from getting too big. Taxing more heavily in times of abundance is useful way to put breaks on economy.

Question 14

Describe the difference between movement along, and a shift of, the AS curve.

Answer 14

• movement along curve when average price level changes.

- shift of AS curve if there’s a change in the costs of production faced by all firms

Question 15

Explain how changes in costs of raw materials and energy influence short-run AS.

Answer 15

• in developed country most raw materials imported and, if global competition increases costs fall in that country.
• the cost of these imports depends on demand pressures from other parts of the world as well as supply.

Question 16

Explain how changes in exchange rte influence short-run AS.

Answer 16

If euro falls in value relative to pound, many costs would fall in the UK, meaning that AS in UK increases.

Question 17

Explain how changes in tax rates influence short-run AS.

Answer 17

If increase in indirect taxes, there will be an increase in costs for almost all firms in the UK. Increase in taxes said to decrease AS curve.

Question 18

Describe how technological advances influence long-run AS.

Answer 18

Innovation and investment in new ideas tend to reduce costs for all firms.

Question 19

Describe how changes in relative productivity influence long-run AS.

Answer 19

Productivity is output per unit of input and, if increases relative to country’s main trading partners, the productivity gap is said to be closing. Means costs of production becoming relatively less expensive.

Question 20

Describe how changes in education and skills influence long-run AS.

Answer 20

Increased spending on education and trining should mean country’s workforce can produce more output per worker. Education increases value of potential output.

Question 21

Describe how changes in government regulations influence long-run AS.

Answer 21

Many regulations in UK economy that have been imposed to try maintain a disciplined economy such as in the postal and telecommunications services. However, such industries have been increasingly deregulated over past 2 decades to increase competition, which in turn imposes its own form of discipline. Net effect is that parcel postage and phone service- costs faced by all firms- have reduced in real terms, shifting AS to right.

Question 22

Describe how demographic changes and migration influence long-run AS.

Answer 22

Decreasing birth rate and increasing life expectancy in the UK will have long-lasting impact on labour force and changes in supply of labour shift AS curve as costs and quality of labour change.

Question 23

Describe how competition policy influences long-run AS curve.

Answer 23

As country opens up to more trade, competition drives down prices and inefficient domestic firms give way to overseas firms with a comparative advantage. Therefore, as globalisation develops, AS increases.

Question 24

Describe the classical shape of the long-run AS curve.

Answer 24

The classical view is that in the long run an economy will operate at full capacity and there will be no unemployed resources in the economy, the AS curve is vertical. If any unemployed resources, prices of these factors will fall until surplus disappears, as long as no government intervention.

Question 25

Describe the Keynesian shape of the long-run AS curve.

Answer 25

Keynesian view is that equilibrium level of output can occur below full employment level of output. According to this view AS curve has a backwards-bending L shape, with 3 distinct sections: spare capacity, bottlenecks and full capacity. Assumption behind this analysis is that an economy can be at equilibrium when it’s not at full employment.

Question 26

Define bottlenecks.

Answer 26

Where restrictions in capacity to increase production occur, meaning that prices will start to rise as output rises.

Question 27

Define AD.

Answer 27

Total amount of planned spending on goods and

services at any price level in an economy

Question 28

Define AS.

Answer 28

The total planned output of goods and services in the UK.

Question 29

Define animal spirits.

Answer 29

The forces that make markets move in large booms and busts, as people buy and sell impulsively rather than calmly, using purely rational behaviour.

Question 30

Describe the demand-side policy responses in the US post 2008 global financial crisis.

Answer 30

President Obama clearly a Keynesian, using fiscal policy to expand economy by getting involved in major infrastructure projects across country.

Question 31

Describe the demand-side policy responses in the UK post 2008 global financial crisis.

Answer 31

In 2010 when Labour Party lost general election and the new coalition government made fiscal balance one of its main short-term objectives. Austerity in a recession followed. Growth was initially slow but by 2014 growth was up to levels seen in USA.

Question 32

What are market based policies as a supply side policy?

Answer 32

Policies which are designed to remove anything that prevents the free market system working efficiently, causing lower output and higher prices.

Question 33

What are interventionist policies as a supply side policy?

Answer 33

Policies designed to correct market failure.

Question 34

Explain improving incentives as a market based policy.

Answer 34

Incentives function by giving people higher rewards for what they do and therefore motivating them to work harder. Most obvious way to do this is to cut marginal income tax rates or reduce corporation tax(tax on firms profit).

Question 35

Explain increasing competition as a market based policy.

Answer 35

• Privatisation, selling nationalised companies to private sectors, or ​deregulation​, reducing restriction on businesses which restrict entry to the market, makes firms more competitive.
• as firms compete they must either cut costs or become more innovative in order to survive, which effectively shifts AS curve to right by reducing costs.

Question 36

Explain reforming the labour market as a market based policy.

Answer 36

-if prices not used to allocate resources effectively there’ll be surpluses or deficits in market.