Circular flow, AD, AS- MM Flashcards
What does the circular flow of income & spending show?
The connections between the different sectors of the economy & the flow of goods, services & FOP between firms and households
What are the two types of flow?
1) Physical flow
2) Monetary flow
What is physical flow?
The movement of goods, services & labour
What is monetary flow?
The movement of money in return for the physical flow
In the real world, what 2 things do dealings with other countries cause to the circularity flow?
1) Outside injections into the economy
2) Leakages from the circular flow
What are 3 ways to measure national income?
1) The expenditure method
2) The income method
3) The output method
What is the expenditure method?
Adding up all expenditures spent on goods & services during a year by economic agents
What is the income method?
Adding up all the income for the FOP & income for self-employed people
What is the output method?
Subtracting inputs/payments made to the FOP of an industry from the industry’s output
What is the relationship between national income, national expenditure and national output?
They are all equal to each other
What is aggregate demand (AD)?
The total value/demand of every good and service demanded in an economy over a period of time
What is PL?
Price level, the overall level of prices in an economy
What relationship do PL and overall demand have?
Inverse relationship
What does an aggregate demand curve look like?
Slope downwards from left to right
What does Y stand for in an aggregate demand diagram?
Real income or Real GDP
What are the labels on an AD/AS diagram?
Curve down= AD
Curve diagonally up= SRAS
Curve straight up= LRAS
Y-axis= PL
X-axis= Y (Real GDP)
What relationship do PL and AD have?
An inverse/ negative relationship. One up, other down. One down, other up.
What is an overall increase in price level also known as?
Inflation
What are the 5 components of AD?
1) Consumption (C)
2) Investment (I)
3) Government expenditure(G)
4) Exports (X)
5) Imports (M)
What is Consumption (comp. of AD)?
Biggest component- total spending on goods and services by households- 60-65% of AD
What is investment (comp. of AD)?
Any addition to capital stock of economy- spending by private sector businesses, most volatile (collapses & accelerates)- 15-20% of AD
What is government expenditure (comp. of AD)?
All government spending on goods and services needed by the country, and may benefit the country in the future- doesn’t include benefits- 20-25% of AD
What is exports (comp. of AD)?
Goods and services produced in this country and are demanded by economic agents in other countries- add value to AD
What is imports (comp. of AD)?
Goods & services produced by other countries but are demanded by economic agents in this country- negative, drain AD
What is the equation for AD?
AD= C+I+G+(X-M)
What are 3 types of leakage that take value away from AD?
1) Imports (M)
2) Savings (S)
3) Taxation (T)
What result does (X-M) usually have and why?
A negative number as M is usually higher than X
What 2 factors affect investment?
1) Interest rates- IR up, I down
2) Uncertainty
What 2 things is the output method also known as?
1) Value-added method
2) Production method
In what type of economy 1) are there 2) no leakages or injections in its circular flow?
1) Real world economy
2) Closed economy
In a circular flow, what 2 things flow from households to firms?
1) Consumer expenditure
2) Factors of production
In a circular flow, what 2 things flow from firms to households?
1) Goods & services
2) Wages, rent & dividends
In a circular flow, where do 1) leakages go from and 2) injections go to?
1) Households
2) Firms
What 5 factors might shift AD to the right?
1) Increase in C
2) Increase in I
3) Increase in G
4) Increase in X
5) A decrease in M
What 5 factors might shift AD to the left?
1) Decrease in C
2) Decrease in I
3) Decrease in G
4) Decrease in X
5) Increase in M
What 2 leakages may shift AD to the right?
1) Decrease in S
2) Decrease in T
What 2 leakages may shift AD to the left?
1) Increase in S
2) Increase in T
What does the size of how much an increase in RDI (Y) will increase C depend on?
Leakages
What other 2 things can affect how much a change in RDI changes C/I?
1) Expectations
2) Consumer/Business confidence
How does consumer/business confidence influence C/I?
Confidence=Spending, Unconfident=Save
What does business confidence affect?
Investment (I)
What does consumer confidence affect?
Consumption (C)
What is Aggregate Supply (AS)?
The total value of goods and services produced in an economy
What method of measuring national income does AD represent/ equal?
The expenditure method/ National expenditure
What method of measuring national income does AS represent/ equal?
The output method/ National output
What does an AS curve look like?
Upwards sloping left to right
What does a SRAS curve look like?
Upwards sloping left to right
What does an LRAS curve look like?
Vertical- perfectly inelastic curve
What is LRAS of an economy dictated by?
The capacity of the economy
What is the capacity of an economy determined by?
The quantity/ quality of the FOP available within the economy- assumed to be fixed
What is the point where LRAS meets the x-axis called?
Y’FE- (FE smaller than Y)
What does Y’FE represent?
Full employment level of national output at a sustainable level- where all FOP are being fully utilised
How can LRAS also be represented?
A PPC diagram
What will a change in PL do on an AS curve?
Increase= Extend
Decrease= Contract
What causes a shift in the AS curve?
Change in determinants of AS
What determines the position of SRAS?
Costs of production in the economy for all firms- higher costs e.g. inflation
What are 5 examples of costs of production that effect all firms?
1) Wages
2) Raw materials/ commodity prices
3) Oil price
4) Business taxes (VAT)
5) Import prices (SPICED)- exchange rate dependent
What is the impact of costs of production to the economy?
Shocks- can change quickly
Why is LRAS vertical?
It represents 1 level of output the economy will always produce at in the long run
What 2 factors cause shifts in LRAS?
1) Q2CELL- Quantity & quality of FOP (CELL)
2) Productive efficiency
What 6 things of Q2CELL & productive efficiency cause a shift right in LRAS?
1) ↑ Labour productivity
2) ↑ Investment- Spending on capital goods
3) ↑ Infrastructure- efficiency
4) ↑ Quantity of labour- immigration/ incentives
5) ↑ Competition- firms reduce costs
6) New resource discoveries
INCREASE IN Q&Q OF FOP
What 5 things of Q2CELL & productive efficiency cause a shift left in LRAS?
1) ↓ Labour productivity
2) Capital depreciation
3) War, conflict, natural disaster- Death/ destroyed infrastructure
4) Health crisis- ↓ productivity
5) Emmigration
DECREASE IN Q&Q OF FOP
What do we assume when using AS or AD?
Ceterus Paribus
What do we assume for AD?
The amount of money circulating the economy remains unchanged
What do we assume for SRAS?
Firms are able to increase their output without increasing costs
When is the economy in equilibrium for AS & AD?
When AS=AD
Why might the LRAS curve be to the right of equilibrium?
Lots of FOP unemployed
Why might the LRAS curve be to the left of the equilibrium?
Economy is over-extended & FOP are being overused (unsustainable)
What is the best position for the economy?
AD=SRAS=LRAS
An increase in what is most beneficial for economic growth?
Aggregate supply
How do you calculate unemployment?
Y’FE-Yn
Why are changes in AS more sustainable than AD?
↑ AS reduces PL, ↑ AD increases PL
What is inflation?
A sustained increase in PL
