Theme 2, CC2

Question 1

aggregate demand

Answer 1

AD
total planned expenditure in an economy at any given possible overall price level
AD = C + I + G + (X-M)

Question 2

link between national income, national output and national expenditure

Answer 2

national income = national output = national expenditure

all known as Y

Question 3

‘real’

Answer 3

adjusted for inflation

Question 4

reasons why the AD curve slopes downwards

Answer 4

• income effect: households on fixed incomes can buy fewer goods/services
• real balance effect: if prices rise, real value of people’s cash savings will fall, save more and spend less to compensate
• international competition: high UK price level makes UK exports less competitive
• higher interest rates: price level rises, interest rates tend to rise, reducing investment and consumption

Question 5

price level

Answer 5

average level of prices in the economy measured by CPI

if CPI goes up, inflation goes up

Question 6

shifts in AD curve outwards

Answer 6

• consumption increases
• investment increases
• government spending increases
• exports increase
• imports decrease

Question 7

aggregate supply curve

Answer 7

shows total quantity of goods and services firms are willing to produce at each price level

Question 8

Keynesian Aggregate Supply curve: stage 1

Answer 8

• easy for firms to use spare resources to increase capacity without the need to increase prices, (no inflation)

Question 9

Keynesian Aggregate Supply curve: stage 3

Answer 9

• all resources of economy are being fully employed (on PPF)
• supply now perfectly inelastic and cannot increase any more to match demand, no matter the price level
• any extra demand is purely inflationary

Question 10

Keynesian Aggregate Supply curve: stage 2

Answer 10

• resources more scarce as capacity of economy is close to being exhausted
• producers pay over time for labour and use less efficient equipment which pushes up unit costs (rising inflation)

Question 11

shifts on AS curve

Answer 11

• production costs (VAT, immigration eg)
• productivity changes
• short term/long term
• technological improvements/declines
• change in exchange rate: cheap to import so imports go up (SPICED)

Question 12

equilibrium

Answer 12

the price level and level of real output where AD is equal to AS

Question 13

what does national income or price level change depend on

Answer 13

• how much AS or AD changes
• how close the economy is to full employment
• whether there are counteracting changes

Question 14

trade deficit

Answer 14

imports > exports

Question 15

the multiplier

Answer 15

an increase or decrease in AD leads to a larger final change in National Income, (GDP)

Question 16

multiplier effect/process

Answer 16

• one person’s spending is another person/s income within the circular flow of income
• if there is an additional injection into circular flow, national income will increase by more than the additional injection

Question 17

marginal propensity to consume

Answer 17

MPC
proportion of change in disposable income which is spent on goods/services in the domestic economy
MPC = change in C / change in Yd

Question 18

marginal propensity to save

Answer 18

MPS
proportion that is saved out of a change in disposable income
MPS = change in S / change in Yd

Question 19

formula for multiplier

Answer 19

multiplier (k) = 1/(1-MPC) = 1/MPS (in closed economy with no government sector)

OR

multiplier (k) = 1/MPW

Question 20

marginal propensity to withdraw

Answer 20

MPW = MPS + MPT + MPM

Question 21

marginal propensity to import

Answer 21

MPM
proportion of change in disposable income which is spent on imports
MPM = change in M / change in Yd

Question 22

marginal propensity to tax

Answer 22

MPT
proportion of a change in income which is paid in tax
MPT = change in T / change in Y

Question 23

effects of the economy on the multiplier …

Answer 23

depends on:

• MPT and MPM, both relatively high in UK making value of multiplier low
• MPS, relatively low for UK but changes over time eg confidence, interest rates
• spare capacity of economy

Question 24

evaluation of multiplier effect

Answer 24

• difficult to know exact size
• not instantaneous
• economists disagree about exact size