The Multiplier and Aggregate Demand/Supply Flashcards

1
Q

What is the multiplier?

A
  • refers to the proportion by which income will rise following the initial change in spending
  • The amount by which real income or GDP changes after an initial change in expenditure
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

Formula for the multiplier

A

K (multiplier) = ∆Y/∆I
K=1/(1-MPC) or =1/MPS
(always has a value greater than one)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

As the MPC increases, the multiplier increases

A
  • This depends on the attitudes towards spending and saving

- It is an average across all households in the economy

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

The multiplier process applies to any autonomous change in expenditure

A
  • Could be a change in consumption, investment, government spending or exports
  • Applies for any decrease in autonomous spending
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

E.g. The GFC

A

2008-09

  • Reduced business and household confidence and led to a fall in investment spending in Australia
  • This then slowed growth in Australia’s GDP and increased unemployment
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

What determines the size of the multiplier?

A

Determined by the factors that affect the marginal propensity to consume

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

What is aggregate demand?

A

The total amount of spending in the economy

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

Aggregate demand curve

A
  • Shows the relationship between the price level and the quantity of real GDP demanded by each of the different sectors: households (C), firms (I), governments and overseas
  • Slopes downwards
  • Describes a negative or inverse relationship between the level of aggregate demand and the price level
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

Three ways to explain the inverse relationship (demand curve)

A
  • The income effect
  • The interest rate effect
  • The open economy effect
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

Income effect

A
  • As the price level rises, the purchasing power of your income falls and consumption decreases
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

The interest rate effect

A
  • Inflation effects interest rates
  • A rise in the general level of prices means that households and firms demand more funds to finance their transactions
  • A rise in the demand for money increases the interest rates, increasing the cost of borrowing, which is a disincentive to spend
  • Inflation wrings upward pressure on interest rates, which has a negative impact on investment and consumption spending
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

Open economy effect

A
  • If the domestic price level (inflation) rises relative to other countries, domestic goods and services become less competitive in those countries, leading to less demand for exports
  • Opposite effect if inflation decreases
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

Inverse relationship in general

A

Increases in the general level of prices can be expected to reduce total spending in the economy and cause a movement upwards and to the left along the AD curve

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

Aggregate supply curve

A

Shows the relationship between the total production of goods and services, and the general price level

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

Two aggregate supply curves

A
  • Short run aggregate supply curve (SRAS)

- Long run aggregate supply curve (LRAS)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

The LRAS curve

A
  • Shows the economy’s potential level of real GDP when all resources are fully employed
  • Shows the economy’s full employment level of output
  • Economy’s natural level of output and natural rate of unemployment
  • It is vertical because it represents the maximum level of output at a particular point in time
  • The level of real GDP does not change as the price level changes
  • The position is determined by the size of the economy’s work force, the quantity of capital and the state of technology
17
Q

The SRAS curve

A
  • Shows the impact of an increase in total production (GDP) on the inflation rate
  • Curve is upward sloping
  • Rising production requires increased resources of labour and capital and this puts pressure on resource prices
  • The most important cost of production is the price of labour – wages
  • As production in the economy increases, wages begin to rise, and this causes an increase in the general price level
18
Q

Keynesian range

A
  • The horizontal section of the AS line
  • Low levels of national output and supply
  • Plenty of unused productive capacity
  • In this area, firms would find it very easy to increase their production levels in response to little or no rise the general level of prices
19
Q

Classical range

A
  • The upper, vertical zone of the AS line
  • Generally, no unused productive capacity
  • Real national production is at its physical limit because all resources are fully employed
  • Even large rises in the general level of prices and the offer of huge profits are not enough for an actual increase in the volume of national production
  • This is because firms cannot get hold of the extra resources that they would require to further lift GDP
20
Q

Intermediate range

A
  • Located at the elbow where the line starts to bend upwards
  • Indicated the gradual onset of full employment where the little excess capacity remaining soon gives way to no unused capacity at all
  • Moving upwards into this zone, bigger and bigger general price rises are needed to make extra production profitable
21
Q

Deficient AD – recession

A
  • Low or falling production will cause rising cyclical unemployment and perhaps even a recession
  • Living standards would fall, despite lower prices
22
Q

Excess AD – boom

A
  • Cannot physically produce anymore
  • Due to excess spending, production cannot keep up, and the economy overheats
  • General shortages of goods and services develop, causing rising prices and demand inflation
  • Living standards suffer as a result
23
Q

Ideal Ad – domestic stability

A
  • Equilibrium would occur near maximum production and employment, but without the problem of rapid inflation in the general level of prices
  • Short-term material living standards should be maximized
24
Q

Favourable supply conditions

A
  • Rise in national output and employment

- Improved economic stability and material living standards

25
Q

Unfavourable supply conditions

A
  • Rising production costs and falling profits
  • Firms may be forced to lift their prices, this accelerating cost inflation
  • Cause an unfavourable economic situation called stagflation (simultaneously low GDP growth, high structural unemployment and rapid cost inflation