Chapter 8

Question 1

Defn. Aggregate Demand (AD)

Answer 1

is the total demand by households, firms, government and foreign sectors for the final goods and services that is domestically produced in the economy at various price levels

It is the total value of goods and services demanded in an economy at a given price

Question 2

Components of AD

Answer 2

AD = C (consumption expenditure) + I (investment expenditure) + G (government expenditure) + X - M

Question 3

Defn. Consumption expenditure

Answer 3

is the total expenditure of households on final goods and services in the economy.

Question 4

Determinants of C

Answer 4

1. Level of interest rates
   -> low i/r -> low cost of borrowing, savings become less attractive -> lower opp. cost of consumption -> encourage households to save less and spend more
2. Govt. policy and disposable income
   -> policy (tax/ transfer payments etc.) -> disposable income of households -> purchasing power -> demand
3. Accessibility of credit
   -> indiv. instalment payments are lowered/ time period of loans are extended -> level of autonomous consumption (C that does not depend on income) increases -> households tend to be more tempted to spend
4. Price expectations
   -> anticipation for higher prices in the future -> households consume more now as it is cheaper to do so
5. Savings
   -> save more, C decrease -> because households need to sacrifice current consumption if they decide to save more. (Eg. periods of high economic uncertainty, such as recessions and econ shocks tend to induce increase in saving rates as people want to prepare for uncertain econ future)

Question 5

Defn. Investment expenditure

Answer 5

expenditure on capital goods such as equipment, plants as well as additions to stocks of raw materials and intermediate goods

Question 6

Determinants of I

Answer 6

1. Level of interest rates
   -> low i/r -> cheaper to borrow from banks -> increase the rate of returns on investments -> raise level of investments made
2. Govt. policy
   -> eg. tax holidays/ lowering corporate tax -> higher returns or profits -> motivate firms to raise their investments
3. Technological improvements
   -> new production techniques that are less costly -> fall in production cost -> greater profits -> ability to earn greater profits motivate firms to raise investments
4. Business expectations
   -> If firm optimistic about future (expects future DD for its goods and their prices to rise) -> inclined to invest now
5. Changes in infrastructure
   -> good communication and transportation network lowers COP -> eg. reduces distribution time, provides accurate info and lowers cost -> encourage investments.

Question 7

Defn. Govt Expenditure

Answer 7

the amount of spending by the government on goods and services

Question 8

Determinants of G

Answer 8

NIL

Level of G is affected by its budget policies and not by the changes in national income.

G does not include expenditure on transfer payments

Question 9

Defn. Export Revenue (X)

Answer 9

refers to revenue received from the sale of goods and services to trading partners

Question 10

Determinants of X

Answer 10

1. Trading partner’s RNY
   -> when a country’s trading partner’s real GDP increases, their trading partner will purchase more imports -> raises export revenue of the domestic country -> increase in net exports
   *influenced by the national income of a country’s trading partner and is independent of the national income of the domestic country
2. Exchange rate
   -> depreciation in exchange rate of domestic currency will make it cheaper for the country’s trading partner to buy more imports -> raises export revenue of domestic country since their exports are the imports of their trading partner
3. Inflation rate
   -> Inflation in domestic country -> prices rise making domestic produced goods and services more expensive -> inflation raises export price -> fall in Qd for exports -> fall in export revenue assuming that demand for exports is price elastic

Question 11

Defn. Import Expenditure

Answer 11

refers to expenditure incurred due to purchases of goods and services from a country’s trading partner

Question 12

Determinants of I

Answer 12

1. Domestic RNY
   -> domestic income increase -> more will be spent on buying imports -> import expenditure increases
2. Exchange rate
   -> depreciation in exchange rate of domestic country -> makes it more expensive for domestic country to buy imported goods -> domestic country will buy less imports -> import expenditure decreases
3. Inflation rate
   -> inflation -> foreign goods are relatively cheaper compared to locally produced goods -> demand for imports rises -> import expenditure increases

Question 13

Defn. Aggregate supply (AS)

Answer 13

the total output that firms in the economy are willing and able to supply at different price levels in a given time period

is the value of goods and services produced in an economy at a given price level

Question 14

Keynesian range

Answer 14

• abundance of unemployed resources
• firms in the economy can purchase more resources to produce more goods, without having to offer higher prices to employ theses resources

Question 15

Intermediate range

Answer 15

• less resources become available and hence shortages of resources occur
  -> shortage -> firms need to offer higher prices to get more resources -> drives up COP -> firms require a higher price in order to produce more goods

Question 16

Classical range

Answer 16

• firms cannot go on raising output since resources in the economy is limited and resources would eventually be fully employed
• even at higher prices, firms will not be able to produce more goods as they will not be able to obtain any additional resources
• AS curve is perfectly inelastic at income level Yf

Question 17

Factors that shift the AS curve

Answer 17

1. Factors that raise the COP
2. Factors that affect the productive capacity

Question 18

1. Factors that raise the COP

Answer 18

increase in COP -> shift AS curve upwards

• increase in price of factor inputs
• increase in wages
• increase in indirect taxation (GST)
• decrease in govt subsidies to firms

Question 19

2. Factors that affect the productive capacity

Answer 19

increase in productive cap. -> shift the whole AS curve downwards and rightwards

• increase in quantity and quality of FOPs
• level of technology

Question 20

Circular flow of income model

Answer 20

• Firms provides goods and services to households
• Firms receive payments known as consumption expenditure on domestically produced goods and services in return
• Households produce factor inputs which include labour, land, capital and entrepreneurship to firms
• Households receive factor income (Y) in the form of wages, rent, interes, and profits
• Household income is also saved, spent on imports, as well as used to pay income taxes (withdrawals) - withdrawals are leakages that goes out of the circular flow of income
• G on goods and services, I and X rev are known as injections

Question 21

Multiplier process formula

Answer 21

^Y = k x ^AD

where k is the multiplier and ^AD represents the initial injection

Question 22

Size of multiplier (k) formulas

Answer 22

k = 1/ (MPS+MPM+MPT) =1/ (1-MPC)
= 1 / MPW

Question 23

Defn. Marginal propensity to consume (MPC)

Answer 23

measures the extent of change in consumption due to a change in national income (also known as induced consumption)

Question 24

Defn. Marginal propensity to save (MPS)

Answer 24

measures the change in savings due to a change in national income

Question 25

Defn. Marginal propensity to tax (MPT)

Answer 25

measures the change in tax revenue collected due to a change in national income

Question 26

Defn. Marginal propensity to import (MPM)

Answer 26

measures the change in import expenditure due to a change in national income

Question 27

Defn. Marginal propensity to withdraw

Answer 27

measures the change in all withdrawals in the economy due to a change in income, which is also the sum of MPS, MPT and MPM