Macroeconomics - L4 Aggregate Demand & Aggregate Supply

Question 1

If consumer sentiment (factor affecting demand) was in decline, what would the impact be on price levels and economic activity?
Increase or decrease? Why?

Answer 1

Price levels and economic activity would both decrease.

This is because consumers are not feeling confident about the state of the economy or their job security. This will reduce spending (private consumption expenditure) on goods and services and AD (AD curve shifts to the left).

Producers will respond by decreasing the volume of G & S produced, thereby decreasing economic activity, placing downward pressure on price levels.

Question 2

If interest rates (factor affecting demand) were to decrease, what impact would this have on price levels and economic activity?
Increase or decrease? Why?

Answer 2

Price levels and economic activity would both increase.

This is because the cost of borrowing has decreased which will incentivise consumers borrow money to spend on G & S. (AD curve shifts to the right).

Both private consumption expenditure and private investment expenditure will increase, increasing AD.

Producers will respond by increasing the volume of G & S produced, increasing economic activity and placing upward pressure on prices.

Question 3

If productivity growth (factor affecting supply) were to increase, what impact would this have on price levels and economic activity?
Increase or decrease? Why?

Answer 3

Economic activity = increase

Price levels = decrease

The increase in productivity growth means producers have increased their outputs from any given level of inputs, meaning they have been able to produce more G & S.
The increase in AS (AS curve shifts to the right) places upward pressure on economic activity and downward pressure on price levels.

Question 4

If climate change caused a drought for farmers (climatic conditions = factor affecting supply), what impact would this have on price levels and economic activity?
Increase or decrease?
Why?

Answer 4

Economic activity = decrease
Price levels = increase

This is because producers have decreased their output from any given level of inputs and this has placed downward pressure on the volume of G & S they have been able to produce.

The decrease in AS (AS curve shifts to the left) creates upward pressure on price levels.