The Aggregate Demand Aggregate Supply Model

Question 1

what is the Aggregate demand definition

Answer 1

• Aggregate Demand is the total amount of goods and services demanded in the economy at a given overall price level and in a given time period. It is represented by the aggregate demand curve, which describes the relationship between price levels and the quantity of output that firms are willing to provide.

Question 2

The aggregate demand curve is downward sloping because…

Answer 2

as the price level drops the quantity of goods and services people are willing and able to buy increases

Question 3

The curve slopes downward from left to right because…

Answer 3

1. Income effect: At a lower price level, consumers are likely to have higher disposable income and therefore spend more (consumption increases).
2. Export Effect: If there is a lower price level, goods will become relatively more competitive, leading to higher exports. (Exports is a component of AD so AD will be higher.)
3. Interest rate effect: At a lower price level, interest rates usually fall, and this causes higher aggregate demand.

Question 4

what will result from a fall in AD

Answer 4

• Fall in net exports (M>X)
• Cut in government spending (G)
• Higher Interest rates
• Decline in Household wealth and confidence

Question 5

what will result from an Increase in AD

Answer 5

• Depreciation of the exchange rate
• Cuts in direct and indirect taxes
• Increase in house prices
• Expansion of supply of credit + lower interest

Question 6

what are some key causes of shifts in AD

Answer 6

• Changes to Monetary Policy
• Changes to government fiscal policy
• Business and consumer confidence

Question 7

what are some External shocks to AD

Answer 7

• A rise or fall in the value of the exchange rate.
• A recession, slow down or boom in one or more of a nation’s key trading partner countries
• A slump in the housing market/ construction sector of a country
• An event such as the GFC which caused a fall in the supply of credit available to businesses and households.
• A large change in commodity prices for a country that is a commodity exporter.

Question 8

factors that affect AS

Answer 8

Input costs

Business taxes, subsidies and imports

supply shocks

Question 9

Key factors that affect a country’s long run aggregate supply

Answer 9

• Higher productivity of labour and capital
• Increased labour market participation
• Gains form innovation and enterprise
• Capital investment

Question 10

policies to increase long run aggregate supply include:

Answer 10

• Expanding the labour supply e.g – improving work incentives
• Increase the productivity of labour e.g – by investment in training of the labour force and improvements in the quality of management of human resources.
• Improved mobility of labour
• Expanding the capital stock
• Increased business efficiency
• Stimulate invention and innovation

Question 11

• Short-run macroeconomic equilibrium occurs when…

Answer 11

occurs when the quantity of real GDP demanded equals the quantity of real GDP supplied at the point of intersection of the AD curve and the SRAS curve.

Question 12

• Long run macroeconomic equilibrium occurs when…

Answer 12

occurs when real GDP equals potential GDP – when the economy is on its LAS curve.