Unit 2.A - Introduction to Key Concepts Flashcards
- Total spending, total output, total input as part of the circular flow of income model - The business cycle - Aggregate Demand - Aggregate Supply - Macroeconomic equilibrium
What is aggregate demand?
Aggregate demand (AD) represents the total amount of spending in the economy; the demand for all goods and services across the whole economy.
What is aggregate supply?
Aggregate supply (AS) is the productive capacity or total output of the economy: describes quality and quantity of all factors of production in the economy. Describes the value of total output over a range of price levels.
What is the relationship between total spending, total output, and total income?
Total spending (or AD) is given by C + I + G + (X-M) and represents all money received by businesses. In exchange for this financial input, businesses use a combination of production factors e.g. raw goods, to produce a volume of goods and services (total output). The returns on the factors of production contributing to total output is received by households as income (rent, waves, capital, and profit (total income).
So total spending = total output = total income, but on the next round total income does not necessarily equal total spending, as the level of leakages or injections may change.
How do terms used in the circular flow of income model translate to terms in an AS/AD market equilibrium diagram?
Total spending = AD = C + I + G + (X-M)
Total output = AS
Total income = GDP or Y
How is microeconomics different to macroeconomics?
Microeconomics is the study of invidiual markets and deals with supply and demand on the scale of a single market (for example market for airpods) whereas macroeconomics is the study of the whole economy, or (large sectors of it) in terms of aggregate demand or demand for all goods and services across the whole economy, and aggregate supply or productive capacity.
How is microeconomic equilibrium different to macroeconomic equilibrium?
Microeconomic market equilibirum considers supply and demand on the scale of a single market (for example market for airpods) with respect to changes in price and equilibrium quantity, while macroeconomic equilibrium considers aggregate demand and aggregate supply across the whole economy with respect to changes in price level (inflation) and GDP (total income).
Microeconomic equilibrium occurs when the quantity demanded = quantity supplied and the equilibrium price and quantity are stable with no tendency to change, so all those who are willing and able to buy or sell may do so.
Macroeconomic equilibrium occurs when the sum of leakages = sum of injections, OR when the value of total spending is reciprocated by an amount of total output (production) of equal value, so that the full employment level of output is not exceeded and inflation does not occur.
What are some examples of factors that may lead to total income not equalling total spending? (On a circ flow model)
If any of the components of C + I +G + (X-M) change:
- Consumers may borrow to lift consumption spending above their income
- Businesses may spend more by investing
- Exports could increase
- Gov. may increase gov. spending
What will consumption change due to?
- Income (MPA: for every dollar you earn, how much do you spend?)
- Change in populations
- Consumer expectations of future
- MPS marginal propensity to save.
- Interest rates
- Income distribution (higher incomes save more, lower incomes spend more)
What will investment change due to?
- Interest rates
- Level of inflation/inflationary expectations
- General economic outlook
- Changes in taxation policy
- Changes in labour productivity
- Change in cost of capital equipment (relative to labour costs)
- Change in regulations
- Many factors influencing consumption will have a similar effect on investment.
What will gov spending change due to?
- Changes in the unemployment rate
- Investment in infrastructure
- Counteracting movements of the business cycle
- Amount of previous debt and willingness of leaders.
What will net exports change due to?
- Exchange rates ($A appreciates, discourages exports)
- Growth rates overseas (people who buy our exports must be doing well themselves).
- Resource availability
- Demand
- Changing levels of productivity
- Exports reflect overseas events, imports reflect strength of Aussie economy.
What is the rough breakdown of components of AD?
- Consumption: ~ 60%
- Investment: ~ 10-15%
- Gov. spending: ~ 20-25%
- Net exports: v. small (sometimes negative)
What happens when any of the components of AD changes?
- AD will shift left (decrease) if there is an decrease in any of the components or shift right (increase) if there is an increase in any of the components.
What are some of the factors influencing AS?
AS describes the productive capacity of the economy: the quality and quantity of its factors of production and and how effectively they’re combined.
- Level of training and education of workforce
- Size of workforce (immigration)
- Minimum wage
- Public infrastructure projects
- Cost and availability of capital
- Technological developments
- Cost of inputs/production factors (e.g. fuel, imported parts: exchange rates, labour costs)
- Laws and regulations (e.g. less regulations boosts AS).
- The tax system (ours isn’t up to date; there’s gains to be made).
- Interest rates
- Competition
What does an AD/AS describe?
- Combining AD and AS allows us to determine the level of production and inflation in the economy with changes in either component. The level of unemployment may be inferred. Thus it helps us discuss the effects of a rise in investment on the broader economy, for example.
- If the AS curve represents potential production, we can only determine the ACTUAL level of production when we consider the level of spending in the economy, thus Y represents amount of productive capacity actually used.
- When there is a conflict between total spending (AD) and the limits of productive capacity (AS) inflation may occur.
- GDP gap represents unused factors of production
