Aggregate Demand, Supply and the Price Level

Question 1

What is aggregate demand?

Answer 1

Total demand of final goods

Question 2

Why is aggregate demand downward sloping?

Answer 2

Because of income and substitution effect

Question 3

What is income effect?

Answer 3

If price increases, you can buy less the same amount of income

Question 4

What is the substitution effect?

Answer 4

If prices increase, you are going to substitute the more expensive product with a relatively cheaper one

Question 5

What are the determinants of AD?

Answer 5

Price level, income, expectations, government spending and international trade

Question 6

What does a change in price level cause for the AD curve?

Answer 6

A movement along the AD curve, any other changes will shift it

Question 7

What is aggregate supply?

Answer 7

Produced within a certain period of time

Question 8

What happens to the AS in the short-run?

Answer 8

Upward sloping

Question 9

What happens to the AS in the long-run?

Answer 9

Vertical

Question 10

What are the determinants of AS?

Answer 10

Price level, technology, quantity and quality of production factors and expectations

Question 11

What does a change in price level cause for the AS curve?

Answer 11

A movement along the AS curve, any other changes will shift it

Question 12

When does the equilibrium occur in the short-term?

Answer 12

Occurs when AD and AS intersect

Question 13

What happens if prices are higher than PL on the graph?

Answer 13

It would lead to excess supply, which would lower the price level

Question 14

What happen if prices are lower than PL on the graph?

Answer 14

It would lead to excess demand, which would increase the price level

Question 15

What is the effect of an increase in AD?

Answer 15

AD shifts to the right, which increase price level and output

Question 16

What is the effect of a decrease in AS?

Answer 16

AS shifts to the left, which increases price level and decreases output

Question 17

What happens in the long-run in AS?

Answer 17

LRAS is vertical, Y is constant and only the price level can change, labour market can return to the long-run equilibrium easily and wages are flexible

Question 18

What policies influence the equilibrium level of the economy?

Answer 18

Demand-side and supply-side policies

Question 19

What are demand-side policies?

Answer 19

They influence the level of aggregate demand (C+I+G+NX)

Question 20

What are supply-side policies?

Answer 20

They influence the aggregate supply

Question 21

What is the aim of supply-side policies?

Answer 21

To shift (increase) to the LRAS to the right

Question 22

What are examples of supply-side policies?

Answer 22

Labour market measures, capital goods, encouraging competition, changing regulations and improving infrastructure

Question 23

What are the difficulties of supply-side policies?

Answer 23

Only valuable if there is a demand, flexibility in the labour market leads to more insecurity and gap between rich and poor might increase, if unemployed become worse off

Question 24

What are the different views on AS?

Answer 24

Classical and Keynesian

Question 25

What is classical?

Answer 25

When wages are very flexible (including downwards) - economy reaches its potential output quickly

Question 26

What is Keynesian?

Answer 26

When wages are sticky (especially downward) - economy would be stuck below potential output and the AS would be very elastic (horizontal)