Chapter 10

Question 1

What is a closed economy

Answer 1

An economy with no international trade

Question 2

What is saving

Answer 2

Income which is not spent

Question 3

What is withdrawal

Answer 3

A leakage of spending power out of the circular flow of income into savings, taxation or imports

Question 4

What is investment

Answer 4

Total planned spending by firms on capital goods produced within the economy

Question 5

What is an injection

Answer 5

Spending entering the circular flow of income as a result of investment, government spending and exports

Question 6

What is equilibrium national income

Answer 6

The level of income at which withdrawals from the circular flow of income equals injections into the flow also the level of output at which aggregate demand equals aggregate supply

Question 7

What is full employment income

Answer 7

The level of income when the economy is producing on its production possibility frontier with no spare capacity

Question 8

What is an open economy

Answer 8

An economy open to international trade

Question 9

What is aggregate demand

Answer 9

Total planned spending on real output in the economy at different price levels

Question 10

What are reflationary policies

Answer 10

Policies that increase aggregate demand with the intention of increasing real output and employment

Question 11

What is aggregate supply

Answer 11

The level of real national output that producers are prepared to supply at different average price levels

Question 12

What is long run aggregate supply

Answer 12

The real output that can be supplied when the economy is on its production possibility frontier. This is when all the available factors of production are employed and producing at their normal capacity level of output

Question 13

What is an economic shock

Answer 13

An unexpected event hitting the economy. Economic shocks can be demand side or supply side shocks and unfavourable or favourable

Question 14

What is the rate of interest

Answer 14

The reward for lending savings to somebody else and the cost of borrowing

Question 15

What is the life cycle theory of consumption

Answer 15

A theory that explains consumption and saving in terms of how people expect their incomes to change over the whole of their life cycles

Question 16

What is the availability of credit

Answer 16

Funds available for households and firms to borrow

Question 17

What is the credit crunch

Answer 17

Occurs when there is a lack of funds available in the credit market, making it difficult for borrowers to obtain financing and leads to a rise in the cost of borrowing

Question 18

What is the distribution of income

Answer 18

The spread of different incomes among individuals and different income groups in the economy

Question 19

What is an accelerator

Answer 19

A change in the level of investment in new capital goods induced by a change in the national income or output. The size of the accelerator depends on the economy’s capital output ratio

Question 20

What is multiplier

Answer 20

The relationship between a change in aggregate demand and the resulting generally larger change in national income

Question 21

What is the marginal propensity to consume

Answer 21

The fraction of any increase in come which people plan to spend on the consumption of domestically produced goods and services

Question 22

What is the marginal propensity to save

Answer 22

The fraction of any increase in come which people plan to save rather than spend

Question 23

What is the normal capacity level of output

Answer 23

The level of output at which the full production potential of the economy is being used

Question 24

What is the equation for AD

Answer 24

AD= C+ I+ G + (X-M)

Question 25

What are the two microeconomic assumptions about the nature of the firms that explain upward slope of the AS curve

Answer 25

All firms aim to maximise profits

In the short the cost of producing extra units of output increases as firms produces more output

Question 26

When would the ad curve shift to a new position

Answer 26

If there is a change in the value of any of the components of aggregate demand

Question 27

What assumption is the AS curve constructed under

Answer 27

All determinants of aggregate supply other than the price level remain unchanged

Question 28

What happens in the long run in terms of aggregate supply

Answer 28

LRAS is not influenced by the price level it reflects the economy’s production potential

Question 29

What is underlying growth determined by

Answer 29

Quantities of capital and labour and other factors of production
Technical progress

Question 30

What are the determinants of consumption

Answer 30

Interest rates 
Level of income 
Expected future income 
Wealth 
Consumer confidence
Availability of credit 
Distribution of income 
Expected future inflation

Question 31

How does expected future income affect consumption

Answer 31

Life cycle theory of consumption

Question 32

What types of wealth is likely to effect consumption

Answer 32

House
Equity release
Share prices
Assets

Question 33

Apart from the rate of interest other factors that influence investment decisions include

Answer 33

Relative prices of capital and labour
Nature of technological progress
Adequacy of financial institutions in the supply of investment

Question 34

What is the multiplier formula

Answer 34

Change in national income / initial change in government spending

Question 35

Factors that cause a rightward shift of the SRAS curve are

Answer 35

A fall in businesses costs of production: including spruce of imported raw materials and energy
A fall in unit labour costs- labour productivity or wage costs
Reduction in indirect taxes such as VAT
An increase in subsidies granted to firms by the government
Technical progress

Question 36

Position of the LRAS curve determined by

Answer 36

State of technical progress
Quantities of capital and labour and other factors of production
Mobility of the factors of production
People’s attitudes towards hard work
Personal enterprise
Existence appropriate economic incentives
Institutional structure of the economy - rule of law efficiency of the banking system