Unit 4 - The Macroeconomy Flashcards
How is the level of activity in the economy determined?
The interaction of aggregate demand and supply (AD AS)
Define
Aggregate Demand
The total demand for final goods and services in the economy at a given time and price level
The amount of goods and services that will be purchased at all possible price level
Equation
Aggregate Demand
and what does each represent
AD = C + I + G + (X-M)
Consumption/Consumer Expenditure
Investment - spending by the private sector on capital goods
Government Spending
Net export = Exports - Imports
Why can’t you explain the downward slope of Ad with the same reasons as an individual demand curve?
A change in price level implies that many prices are changing, including wages paid to workers therefore incomes are changing,(C=a+bY) and consequently it is not possible to assume prices and incomes remain constant
Three reasons for a downward-sloping AD curve
- Wealth effect
- Interest rate effect
- Net exports effect
Explain
The Wealth effect on AD
the AD curve works under the assumption that the governments supply of money/economy’s wealth is held constant. As the price level rises the wealth of a country declines as the purchasing power of the currency falls. so if buyers become less wealthy they can not buy as much as they used to
Describe
The Interest effect on AD
As the price level rises, consumers requre more money to handle they transactions, however the supply of money is still fixed. increased demand for a fixed supply of money leads to increased interest rates
Describe
Net exports’ effect on AD
if the price of domestic price levels increases, demand increases for imports and because domestic goods have a higher price level, demand for exports fall as the goods are now expensive to foreigners
Define
Aggregate Supply
The total output that firmd in a economy are willing and able to supply at diffrent price levels in a given period of time
Define
SRAS
short run aggregate supply
output which will be supplied at different price levels in a period of time when the factors of production remain unchanged or fixed
Describe
Why SRAS and Price level have a direct relationship?
higher price enables firms to meet extra costs and enjoy higer profit margins and producers are more willing and able to supply more goods
State
Reasons for SRAS and Price levels’ positive relationship
- Profit effect
- Cost effect
- Misinterpretation effect
Describe
Profit effect on SRAS
price level increses with the price of factor of production held constant, the gap between output and input prices widents therefore profit increases
Describe
Cost effect on SRAS
Average cost may rise as output increases, even thoughwge rates and raw materials stay constant, overtime and the miscellaneous costs must be paid. To compensate producers will require higher prices
