topic 1 Flashcards
define aggregate demand
the total demand for goods and services produced in an economy at a given price level and in a given time period
AD equation
AD=C (consumer spending) + I (investment) + G (gov spending) + X-M (net exports)
factors influencing C
real disposable income
wealth (value of assets household holds)
consumer confidence and expectations
rate of interest (how expensive it is to borrow money etc, reduces incentive to save)
inflation
age structure of pop (young tend to spend more)
explain the position of the consumption function diagram and what this shows us (‘evaluate the relationship between consumption and income’)
the position of the consumption function will depend on the factors influencing C
there is a clear relationship between income and consumption-inc in income leads to inc in consumption (keynes)
however the extent to which an inc in income will inc consumption depends on the proportion of additional income households will save
factors influencing I
rate of interest (lower=borrowings cheaper=cheaper to invest) current profit levels (use profit for inv)
expectations/confidence about future
changes in real disposable income (firms invest to reach future inc in demand)
advances in tech
factors influencing G
level of market failure and intervention
level of economic activity (unemployment/inflation)
political reasons (pleasing electorate)
other factors-war, terrorist attacks, crime
factors influencing X-M
real disposable income at home (inc income, inc demand for imports)
real disposable income abroad (incomes inc=buy more exports)
domestic price level relative to price level abroad (if uk inflations higher=demand for uk exports fall=demand for uk imports rise)
gov restrictions on free trade
drawing AD curve key points
- the AD curve is downward sloping (same as demand curve)
- real GDP is on the x axis
- price level is on the y axis
- a change in the price level causes a movement along curve
- a change in any of the determinants of the components of AD will cause a shift
define short run aggregate supply
when the prices of the factors of production are assumed not to be changing eg capital is fixed (cant expand capital, would just make existing workers work longer hours etc)
explain using a diagram the relationship between AS and the price level in the short run
- upward/positively sloping (same as supply curve)
- real GDP on x axis
- price level on y axis
- if price level increased, induces firms to increase supply in short run (maximise profit), increasing output
causes of shifts in AS
COSTS
- cost of raw materials
- change in wage rates
- change in domestic production environment (eg closer to transport systems=reduce transport costs)
- changes in exchange rate (if it falls=price of imports increase=increase costs for firms)
- changes in tax rates etc eg VAT (taxes firms have to pay)
- changes in minimum wage
define long run aggregate supply
when the factors of production are variable eg the price of inputs is not fixed
neoclassical view of LRAS
in the long run the economy would always find its way to overal equilibrium which corresponds to a situation which the economy is at full employment (economy is making full use of factors of production, therefore producing at full capacity level of output)
the economy is always at YFE in the long-run
‘the economy has returned to YFE-the LRAS curve must be vertical in long run’ explain using a diagram
- AD falls, shifting it to the left
- classical economists say we will adjust and workers will accept lower wages to reduce costs to firms to shift SRAS to the left and get back to YFE
keynesian view of LRAS
the macro economy isnt sufficiently flexible eough to enable continuous full employment
- policy intervention may be needed to move towards full employment
- AD is sensitive to the price level when economy is below full employment
causes of shifts in LRAS
quantity of:
labour (channge in immigration policies, demographic changes eg ageing pop)
capital (inc investment)
land (new/improved sources of natural resources)
enterprise (schemes encouraging business+help)
effectiveness of:
labour (inc in gov funding for education and training)
capital (spending in research and development eg new tech)
land (eg harnessing power of water better)
enterprise (improved business education+help)
define macroeconomic equilibrium
a state of national economic activity wherein AD is equal to AS
macroeconomic equilibrium in short run
keynesian macroeconomic equilibrium in long run
neoclassical macroeconomic equilibrium in long run
how can we reconcile (price level dropped) neoclassical short and long run macro equilibrium
AD shifts to right due to increase in AD
workers want high wages (working longer)
this increases costs
SRAS shifts to the left
how can we reconcile (price level increased) neoclassical short and long run macro equilibrium
AD shifts to left do to a decrease in AD
workers willing to accept lower wages
supply increases
SRAS shifts to the right
define multiplier
the process by which any change in a component of AD results in a greater final change in real GDP
(it is the act of spending that allows the multiplier effect)
injections into the circular flow can initiate the multiplier effect but leakages determine size of the effect
factors that determine the size of the multiplier
how much additional income is:
saved by households
returned to the gov in the form of direct taxes
spent on imports
APC formula
APT formula
APS formula
APM formula
APW formula
total consumption/total income
total taxes/total income
total savings/total income
total imports/total income
total leakages/total income (APS+APT+APM)
MPC formula
MPW formula
MPS formula
MPT formula
change in consumption/change in income
change in leakages/change in income
change in savings/change in income
change in tax/change in income
multiplier formula and which diagram?
K(multiplier)=1/MPW
use a LRAS macroeconomic equilibrium diagram and show a shift in AD
define accelerator and give example
a theory by which the level of investment depends upon the change in real output (if ouput increases due to increase in AD, accelerator induces an increase in investment)
eg-capital investment in renewable energy as the balance of energy supply shifts towards renewables
how can the accelerator effect come about-4marks
- firms will respond to growing demand by expanding production and making fuller use of their existing productive capacity, or by running down their stocks of finished products
- at some point if they feel that the higher level of demand will be sustained they may inrease spending on capital goods eg factories to increase their capacity. if this investment goes beyond replacing what’s worn out, capital stock of the business will become larger
- the demand for capital goods is being driven by demand for products the firm is supplying to the market=gives rise to accelerator effect
accelerator diagram and explain
neoclassical LRAS with SRAS and AD
1-AD shifts to the right (AD1) due to a change in income=increased spending
2-new equilibrium P1Y1
3-firms feel demand will be sustained=invest in capital=shifts LRAS to LRAS1 (as capacity increases)
4-final equilibrium P2YFE1
define ouput gaps
the difference between the actual level of real GDP and the full employment level
eg (YFE-Y1)=negative ouput gap as there are unemployed rescources
(Y1-YFE)=positive ouput gap as using all FoP at possible unsustainable level
negative consequences of a positive ouput gap
-in the long run wages will rise etc=costs increase for firms, reduces SRAS causing a shift to the left (SRAS1), returns to YFE ouput BUT at a higher price level
=
UK less internationally competitive due to higher inflation etc
negative consequences of a negative ouput gap
- falling output (producing less) can lead to possible unemployment slowing economic growth
- possible downward pressure on the price level (good if prices are too high) due to reduced costs causing SRAS to shift right to SRAS1 (neoclassical)
- fall in investment=fall in AD=negative ouput gap=price level falls HOWEVER deficient demand has resulted in permanent unemployment/lower real GDP (keynesian)
