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Introduction To Business Economics > Week 7 - AD/AS Analysis model > Flashcards

Week 7 - AD/AS Analysis model Flashcards

1
Q

What is the use of the AD/AS model?

A

To explain the price level (inflation rate) and level of output (GDP) via a relationship between aggregate demand and aggregate supply

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2
Q

X and Y variables in AD/AS model

A
  • Y - price level (represent inflation)
  • X - output (represents economic growth)
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3
Q

What is aggregate supply?

A

Is the total supply of goods and services that firms plan on selling during a specific time frame - sim of every firms supply curve

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4
Q

Interpret a short-run aggregate supply curve (4)

A
  • Upward sloping just like a firm’s individual supply curve
  • Higher prices mean higher profits which incentivises businesses to expand output by hiring additional factors
  • Prices of additional factors stay constant when moving along SRAS curve e.g wage and tech
  • In the very SR we can assume that SRAS is perfectly elastic
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5
Q

What are Shifts in SRAS caused by?

A

changes in the conditions of supply such as cost of capital, cost of raw materials, commodity prices, cost of labour, government prices

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6
Q

Interpret a graph showing shifts in the SRAS

A

Increase in the cost of capital and cost of labour will shift the curve from SRAS1 to SRAS3 and a decrease will shift curve from SRAS1 to SRAS2

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7
Q

What determines the position of a LRAS curve? (2)

A
  • State of technology
  • Rate of invention
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8
Q

Characteristics of a Long run aggregate supply (LRAS) curve

A
  • Shows the output firms wish to supply at each price level
  • In the long run equilibrium output is independent of price because it is perfectly inelastic
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9
Q

3 types of aggregate supply curves

A
  • Keynesian = perfectly elastic (inflexible prices)
  • New classical model = perfectly inelastic (flexible prices
  • Upward sloping = SRAS
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10
Q

Draw an aggregate demand curve

A
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11
Q

3 main reasons why aggregate demand curves slop down

A
  • International competitiveness effect
  • Real balance effect
  • Interest rate effect
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12
Q

Why does the international competitiveness effect cause an aggregate demand curve to slope down?

A

Because when the economy’s price level rises the relative price of exports rises while the relative price of imports falls

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13
Q

Why does the real balance effect cause an aggregate demand curve to slope down?

A

Because when the economy’s price level rises the purchasing power of wealth such as financial assets falls

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14
Q

Why does the interest rate effect cause an aggregate demand curve to slope down?

A

Because when the economy’s price level rises the demand for money rises putting upward pressure on interest rates

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15
Q

Aggregate demand equation

A
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16
Q

Factos that impact domestic consumption demand (C) (5)

A
  • Income
  • Interest rates
  • VAT
  • Confidence
  • Wealth
17
Q

Factors that impact domestic investment demand (I) (4)

A
  • Animal spirits - confidence in investment
  • Interest rates - increased will lead to less investments
  • Corporate tax rates - increase will lead to less investment
  • Business subsidies - Increase will lead to greater investment
18
Q

Factors that impact government spending (G) (3)

A
  • Interest rates to finance borrowing
  • Tax collection infrastructure - if it’s not good G will be lower
  • Political preferences
19
Q

Factors that impact export (X) and Import (M) demand (3)

A
  • Exchange rates
  • Domestic income
  • Foreign income
20
Q

Why might aggregate demand shift when price is constant? (3)

A
  • Chnages in consumption habits
  • Animal spirits and consumer confidence
  • Expansionnary fiscal policy
  • Expansionary monetary policy

(Increases will cause it to shift to the right whilst decreases will cause it to shift to the left)

21
Q

What is the classical view on fiscal and monetary policy?

A

In the long-run chnages in fiscal and monetary policy have no impact on output

22
Q

Impact of an increase in government spending (4)

A
  • AD shifts from AD to AD
  • If there was excess capacity the economy would move to position B, but there is no excess capacity available
  • Price rises, economy overheats, interest rates thus reducing investment and consumer spending and we move back to position to C
  • If that happens quickly this creates inflation
23
Q

What happened during The Great Recession and credit crunch? (3)

A
  • Credit dried up, investment and consumer demand fell - represented through shift from AD to AD2
  • At there is a negative output gap which shows there is unemployment and falling prices but real wages have increased for those still in work
  • If the govermenent & central bank does nothing then the excess supply of labour in the labour market will bring down the nominal wage - as a result SRAS shifts down and we end up at C where we are now at full employment
24
Q

Stagflation of the 1970s (7)

A
  • Oil shock shifts SRAS to SRAS2
  • Animal spirits dented so AD shifts to AD2
  • Stagflation causes the economy to go from A to B
  • Energy inflation generates pay disputes and therefore workers’ pay is increased
  • This causes SRAS to shift further to the left as cost-push inflation plagues the economy
  • If the govermenent stimulates the demand (AD shifts to the right) more inflation results demand pull inflation
  • To get to C costs need to fall - the economy needs to be reliant on oil which shifts SRAS2 to SRAS3
25
Q

Keynesian economists thoughts on how quickly the economy adjusts (3)

A
  • Argue that wages and prices are “sticky downwards” this means the adjustment is sluggish
  • Active stabilisation policies are needed to get the economy back to equilibrium or economy will be stuck below full employment
  • Labour Party would agree with this
26
Q

Classical economics thoughts on how quickly the economy adjusts (3)

A
  • Argue that the economy should be left alone to adjust by itself
  • They would argue that government intervention has lots of unintended consequences and should pay off debt
  • Conservative party would agree
27
Q

How does a budgeted deficit/surplus occur? (2)

A
  • Governments are constrained by how much they can increase government spending and/or decrease tax
  • And if a government is spending more/less than what it earns in tax revenue it is running a budgeted deficit/surplus
28
Q

How can a budgeted deficit be financed? And impact (3)

A
  • Governments borrow from financial markets
  • Sell gilts with varying levels of maturing
  • This adds to the stock of public debt which the government pay interest on
29
Q

Impact of national debt

A

Can put upward pressure on interest rates and burden future governments but historically the debt ratio is low

30
Q

What does paying national debt depend on?

A

A country’s ability to control its own currency as a result money can be printed to pay off their debt but this can create hyperinflation

31
Q

Interpret short run AD/AS model which analyses COVID-19

A
  • Negative AD shock and negative AS shock
  • Significant depress in real national income
32
Q

Interpret medium run AD/AS model which analyses COVID-19 (2)

A
  • As pandemic eases and vaccines are introduced the economy begins to recover
  • Pent-up demand shifts AD back, SRAS starts to move back but perhaps more slowly and we start to see a rise in inflation
33
Q

Interpret long run AD/AS model which analyses COVID-19

A

Growth in potential national income is important for living standards

34
Q

Define hysteresis

A

Refers to an event in the economy that persists into the future, even after the factors that led to that event have been removed

35
Q

Interpret a hysterisis growth path (3)

A
  • No hysteresis (red line)
  • Hysteresis as output losses permanent but predetermined rate of growth (blue line)
  • Superhysteresis as output losses are permanent and longer term growth rate is lower

Introduction To Business Economics (9 decks)

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