Chapter 17

Question 1

What is an aggregate of demand?

Answer 1

An aggregate demand curve shows the amounts of real output that buyers collectively desire to purchase at each possible price level. An aggregate demand measures the real total domestic output in terms of GDP.

Question 2

Why is the aggregate demand curve slop negative?

Answer 2

• Real balance effect - a higher price level reduces the purchasing power
• Interest rate effect - by increasing the demand for money and the interest rate, a higher price level reduces the amount of real output demand
• foreign purchase power-

Question 3

How does an aggregate demand curve relate to investment and the multiplier?

Answer 3

The immediate effect of the increase in investment is an increase in aggregate demand by the exact amount of the new spending. The multiplier process magnifies the initial increase in investment into successive rounds of consumption spending and an ultimate multiplied increase in aggregate demand to the right.

Question 4

How does aggregate demand curve change real GDP?

Answer 4

A change in the price level will change the amount of aggregate spending and therefore change the amount of real GDP demanded by the economy.

Question 5

What are the two components that a change in aggregate demand involve?

Answer 5

• A change in one of the determinants of aggregate demand that directly changes the amount of real GDP demanded
• A multiplier effect that produces a greater ultimate change in aggregate demand than the initiating change in spending

Question 6

What are the determinants of aggregate demand and multiplier effect?

Answer 6

• Consumer spending
• Consumer wealth
• Consumer expectations
• Household debt
• Personal taxes
• Investment spending
• Real interest rates
• Expected returns
• Government expenditure/spending
• Net Export spending

Question 7

How does consumer spending affect the aggregate of demand?

Answer 7

Consumer spending - If consumers decide to buy more output then the aggregate demand shifts to the right. Decide to buy less output, the aggregate demand curve will shift to the left

Question 8

How does consumer wealth affect the aggregate of demand?

Answer 8

Consumer wealth - Includes both financial assets such as stocks and bonds and physical assets such as house and land. A sharp increase in the real value of consumer wealth prompts people to save less and buy more products, the resulting increase in consumer spending will shift the aggregate demand curve to the right. Decrease in the real value of consumer wealth at each price level will reduce consumption wealth at each price level will reduce consumption spending and thus shift the aggregate demand curve to the left

Question 9

How does consumer exception affect the aggregate of demand?

Answer 9

Consumer expectations - When consumers expect their future real income to increase they will spend more now, the aggregate demand curve shifts to the right. When expectations of lower future prices may reduce current consumption and shift the aggregate demand curve to the left.

Question 10

How does household debt affect the aggregate of demand?

Answer 10

Household debt - Increased household debt enables consumers collectively to increase their consumption spending, demand curve to the right

Question 11

How does personal taxes affect the aggregate of demand?

Answer 11

Personal taxes - If there is a decrease in taxes then the Yd increases so C increases and therefore shift the demand curve to right

Question 12

How does investment spending affect the aggregate of demand?

Answer 12

Investment spending - A decline in investment spending at each price level will shift the aggregate demand curve to the left. Increase in investment spending will shift to the right

Question 13

How does real interest rates affect the aggregate of demand?

Answer 13

Real interest rates - If the real interest (i) increases then the investment decreases. An increase in real interest rates will lower investment spending and reduce aggregate demand. A decrease in the money supply raises the interest rate, reducing investment and decreasing aggregate demand.

Question 14

How does expected returns affect the aggregate of demand?

Answer 14

Expected returns - Higher expected returns on investment projects will increase the demand for capital goods and shift the aggregate demand curve to the right. Declines in expected returns will decrease investment and shift the curve to the left.

Question 15

How does government expenditure/spending affect the aggregate of demand?

Answer 15

Government expenditure/spending - An increase in government purchase will shift the aggregate demand curve to the right, as long as tax collections and interest rates do not change as a result. A reduction in government spending will shift the curve to the left.

Question 16

How does net export spending affect the aggregate of demand?

Answer 16

Net Export spending - Higher SA exports mean an increased foreign demand for SA goods. A rise in net exports shifts the aggregate demand curve to the right. A decrease in SA net exports shifts the aggregate demand curve leftward.

Question 17

What are the factors that the expected returns are influenced by?

Answer 17

• Expectations about future business conditions
• Technology
• Degree of excess capacity
• Business taxes

Question 18

How does the degree of excess capital affect the expected returns?

Answer 18

Degree of excess capacity - a rise in excess capacity will reduce the expected return on new investment and hence decrease aggregate demand. When firms discover that their excess capacity is dwindling, their expected returns on new investment in factories and capital equipment rises. They increase their investment spending and the aggregate demand curve shifts to the right

Question 19

How does business taxes affect the expected returns?

Answer 19

Business taxes - An increase in business taxes will reduce after tax profit form capital investment and lower expected returns

Question 20

How does technology affect the expected returns?

Answer 20

Technology - new and improved technology enhance expected returns on investment and thus increase aggregate demand

Question 20

How does expectations about future business conditions affect the expected returns?

Answer 20

Expectations about future business conditions - if firms are optimistic about future business conditions, they are more likely to forecast high rates of return on current investment and therefore may invest more today.

Question 21

What are the factors that cause net export spending to change?

Answer 21

• National income abroad - Rising national income encourages foreigners to buy more products, some of which are made in SA. The SA aggregate demand curve shifts to the right. Declines in the national income abroad shifts the aggregate demand curve to the left
• Exchange rates - Rand depreciation increases net exports, (imports go down and exports go up) which increase aggregate demand

Question 22

What is a short run aggregate supply curve?

Answer 22

It is a period in which nominal wages and other resource prices do not respond to price level changes. Nominal wages do not adjust to changes in price level and perfect adjustment may take several months or even years.

Question 22

What is an aggregate supply curve?

Answer 22

An aggregate supply curve measures the real total supply in terms of GDP. It is the level of real domestic output that firms will produce at each price level.

Question 23

What are the determinants of aggregate supply?

Answer 23

• Input in domestic prices
• Prices of imported resources
• Productivity
• Business taxes and subsidies
• Government regulations

Question 24

How does government regulations affect aggregate supply?

Answer 24

Government regulations - it is usually costly for business to comply with government regulations and tends to increase per-unit production costs and shifts the aggregate curve to the left.

Question 25

How does productivity affect aggregate supply?

Answer 25

Productivity - It’s the measure of the relationship between a nation’s level of real output and the amount of resources used to produce that output. An increase in productivity enables the economy to obtain more real output from its limited resources, by reducing the per-unit cost of output which shifts the aggregate supply to the right

Question 26

How does the price of imported goods affect aggregate supply?

Answer 26

Prices of imported resources - Resources imported from abroad add to SA aggregate supply. Added supplies of resources reduce per unit production costs. A decrease in the price of imported resources increases SA aggregate supply, while an increase in their price reduces SA aggregates supply. If the price of imported intermediate goods decreases, then domestic supply increase

Question 27

How does input of domestic prices affect aggregate supply?

Answer 27

Input in domestic prices - A decrease in wages reduces per-unit production costs, the aggregate supply curve shifts to the right. Increases in wages shift the curve to the left.

Question 28

What causes demand-pull inflation?

Answer 28

When the economy is operating at its full employment output and businesses and government decide to increase their spending the aggregate demand curve shifts to the right. The increase in aggregate demand beyond the full employment level of output causes demand-pull inflation, because the price level is being pulled up

Question 29

What causes the real output to decline in aggregate demand?

Answer 29

• Fear of price wars
• Menu costs
• Wage contracts
• Morale, effort and productivity
• Minimum wage

Question 30

What causes cost-push inflation?

Answer 30

When prices spread through the economy, driving up production and distribution costs on a wide variety of goods. Aggregate supply curve shift to the left. The resulting increase in the price level would be cost-push inflation.