MACRO EQUILIBRIUM ANALYSIS - TOPIC 2

Question 1

WHAT IS AD?

Answer 1

THE TOTAL DEMAND OF NEW GOODS AND SERVICES IN AN ECONOMY OVER A PERIOD OF TIME.

Question 2

WHAT IS THE FORMULA FOR AD?

Answer 2

CONSUMPTION + INVESTMENT + GOVT SPENDING + EXPORTS - IMPORTS

Question 3

WHAT IS CONSUMPTION?

Answer 3

SPENDING BY HOUSEHOLDS ON DOMESTICALLY PRODUCED GOODS AND SERVICES.

Question 4

WHAT PERCENTAGE OF AD IS CONSUMPTION?

Answer 4

60%

Question 5

WHAT IS INVESTMENT?

Answer 5

SPENDING BY FIRMS AND GOVT ON CAPITAL GOODS.

Question 6

WHAT PERCENTAGE OF AD DOES INVESTMENT TAKE?

Answer 6

15-20%

Question 7

WHAT PERCENTAGE OF AD IS GOVT SPENDING?

Answer 7

18-20%

Question 8

WHAT PERCENTAGE OF AD IS THE TRADE BALANCE?

Answer 8

5%

Question 9

WHAT CAUSES A SHIFT IN THE AD CURVE?

Answer 9

CONSUMPTION
INVESTMENT
GOVT EXPENDITURE
TRADE BALANCE

Question 10

WHY IS THE AD CURVE THAT SHAPE?

Answer 10

1. IF PRICE LEVEL IS HIGH, CONSUMPTION FALLS AS PURCHASING POWER WILL NOT GO AS FAR WITH HIGHER PRICES.
2. EXPORTS WILL FALL AND IMPORTS WILL RISE AS UK GOODS ARE EXPENSIVE RELATIVE TO OTHER COUNTRIES

Question 11

WHY IS CLASSICAL LRAS THAT SHAPE?

Answer 11

CLASSICAL ECONOMISTS E.G HAYEK BELIEVE THAT IN THE LONG RUN, THE ECONOMY WILL ALWAYS SELF CORRECT SO ECONOMY WILL ALWAYS BE OPERATING AT FULL CAPACITY AS IT IS UTILISING ALL FACTORS OF PRODUCTION.

Question 11

WHY IS SRAS THAT SHAPE?

Answer 11

IN THE SHORT RUN, INCREASING PRODUCTION IS LIKELY TO INCREASE COSTS AND HENCE PRICES.

Question 12

WHY IS KEYNESIAN LRAS THAT SHAPE?

Answer 12

KEYNESIANS BELIEVE THAT FIRMS WON’T ALWAYS PRODUCE AT MAX OUTPUT SO SPARE CAPACITY IS CREATED. AS DEMAND INCREASES, OUTPUT INCREASES WITHOUT SIGNIFICANT IMPACTS ON INFLATION UP UNTIL THE POINT WHERE ALL RESOURCES ARE USED UP. AT THIS POINT, KEYNESIAN LRAS BECOMES PERFECTLY INELASTIC.

Question 13

WHAT CAUSES SHIFTS IN SRAS?

Answer 13

CHANGE IN PRODUCTION COSTS FOR FIRMS.

Question 14

WHAT ARE EXAMPLES OF FACTORS THAT SHIFT SRAS?

Answer 14

1. CHANGES IN RAW MATERIAL PRICES
2. CHANGES IN INDIRECT TAXES
3. CHANGES IN LABOUR COSTS
4. CHANGES IN SUBSIDIES
5. CHANGES IN REGULATIONS

Question 15

WHAT CAUSES SHIFTS IN LRAS?

Answer 15

CHANGES IN QUALITY OR QUANTITY OF THE FACTORS OF PRODUCTION

Question 16

WHAT IS A BOTTLENECK?

Answer 16

WHEN THERE IS LIMITED SUPPLY OF 1 FACTOR OF PRODUCTION.

Question 17

WHAT ARE EXAMPLES OF BOTTLENECKS?

Answer 17

1. LACK OF RAW MATERIALS
2. LACK OF SKILLED LABOUR (E.G NOT ENOUGH NURSES POST BREXIT)
3. INSUFFICIENT CAPITAL

Question 18

WHAT IS MEANT BY SPARE CAPACITY?

Answer 18

UNDER UTILISATION OF FOP SO THERE’S ROOM TO INCREASE OUTPUT AS THE ECONOMY ISN’T OPERATING AT FULL EMPLOYMENT.
CAN DRAW A PPF TO SHOW SPARE CAPACITY.