chapter 11 - AD & AS

Question 1

equilibrium

Answer 1

When AD = AS

Question 2

recessionary situation

Answer 2

(Ye < Yf)
economy below full employment level
AD must be increased to reach desired full employment output level
AD has to be increased in order to reach the new income level.

Question 3

inflationary situation

Answer 3

the economy is above full employment level (Ye > Yf)
the AD must be decreased to reach the desired full employment output level.

Question 4

income multiplier effect

Answer 4

change in output/change in AD

Question 5

MPC

Answer 5

MPC = change in consumption / change in output

Question 6

MPS

Answer 6

MPS = change in saving/change in output

Question 7

MPC + MPS =?

Answer 7

1

Question 8

alt multipler

Answer 8

multiplier = 1/MPS

Question 9

change in output

Answer 9

change in y = 1/MPS x change in initial spending /change in AD

Question 10

determinants of consumption

Answer 10

a) Expectations
Consumer expectations are optimistic or pessimistic views of the future which can change consumption spending in the present.
b) Wealth
An increase (decrease) in financial wealth (money, savings accounts, stocks) leads to a rise (fall) in consumption expenditures.
c) Interest Rate
More durable goods (cars, furniture and appliances) are purchased with borrowed funds. A lower rate of interest on loans encourages consumers to borrow more and consume more and a higher interest rate discourages borrowing, so they consume less.

Question 11

determinants of investment

Answer 11

a) Expectations
Firms’ expectations concerning the economy can affect investment. If firms expect an expansion in the economy, they are likely to increase investment expenditures (rightward shift of AD).
b) Technological Change
Technological progress gives rise to the introduction of new products and the need to replace obsolete capital equipment. Hence new technologies create investment spending thereby causing investment to increase.
c) Interest Rate
Capital goods are usually bought with borrowed money. An increase (decrease) in the interest rate leads to an increase (decrease) in the cost of borrowing. Firms will therefore, borrow lesser (more) causing investment to fall (rise).

d) Government Policies
An increase in business taxes would lower profitability and decrease investment.
On the other hand, the government may wish to encourage investment by allowing a tax credit for new investment. Investments will increase.
e) Depreciation
Depreciation is the wearing out of existing capital equipment. The larger the amount of capital equipment and the older that stock, the larger is the amount of capital that wears out. Therefore, more investment is needed to replace that worn-out capital.