Macro – AD and AS

Question 1

What are the Components of Aggregate Demand?

Answer 1

1) Consumption spending
2) Investment spending
3) Government spending
4) Net exports

Question 2

What are the Determinants of Consumption Spending?

Answer 2

• Consumer confidence
• Interest rates
• Wealth
• Income taxes
• Level of household indebtedness
• Expectations of future price levels

Question 3

What are the Determinants of Investment Spending?

Answer 3

• Interest rates
• Business confidence
• Technology
• Business taxes
• Level of corporate indebtedness

Question 4

What are the Determinants of Government Spending?

Answer 4

Political and economic priorities.

Question 5

What are the Determinants of Net Exports?

Answer 5

• Income of trading partners
• Exchange rates
• Trade policies

Question 6

What causes a shift in AD?

Answer 6

Any change in the determinants of AD.

Question 7

What does the SRAS Curve represent?

Answer 7

Shows the positive relationship between the price level and quantity of output (real GDP) produced by firms when resource prices do not change.

Question 8

What are the Determinants of the SRAS Curve?

Answer 8

All changes to costs of factors of production including:
• Wages
• Non-labor resources
• Indirect taxes (increase costs)
• Subsidies (decrease costs)
• Supply shocks (war, weather)

Question 9

Explain Macroeconomic Equilibrium in the Short-run

Answer 9

(In the AD-AS model) Occurs where AD = SRAS

Question 10

How does the SRAS Curve show changes in Firms’ Profit?

Answer 10

When there is an increase in price level caused by a rightward shift of SRAS, profit will increase.

Question 11

How is LRAS interpreted according to the New Classical Perspective?

Answer 11

Shows the relationship between real GDP produced and the price level when resource prices change. In the AD-AS diagram it is vertical at full employment level.

Question 12

Explain Macroeconomic Equilibrium in the Long-Run according to the New Classical Perspective

Answer 12

Long-run equilibrium occurs at the point where AD and SRAS intersect at the point with the LRAS curve at the level of full employment or potential output.

Question 13

What is an Inflationary Gap?

Answer 13

When real GDP is larger than potential GDP and unemployment is lower than the natural rate of employment.

Question 14

What is a Deflationary Gap?

Answer 14

When real GDP is lower than potential GDP and unemployment is higher than the natural rate of employment.

Question 15

What is the Relationship between the LRAS and Employment according to the New Classical Perspective?

Answer 15

The vertical LRAS shows that the economy will produce at potential output independently of price changes. Doing so, at potential output there is full employment of resources.

Question 16

Why do Inflationary and Deflationary Gaps not persist in the Long-run according to the New Classical Perspective?

Answer 16

The new classical perspective believes the economy has a natural tendency towards full-employment. It assumes that, due to wage and price flexibility, the economy will curb output gaps returning at the full employment level.

Question 17

According to the New Classical perspective what Effects will Changes in AD cause to the Economy?

Answer 17

Changes in AD will only affect the economy in the short-run, whereas in the long-run it may only change the price level (cause inflation or deflation) having no impact on real GDP which remains constant at full employment level.

Question 18

Explain AS according to the Keynesian Perspective

Answer 18

The Keynesian AS curve is divided in three sections: the first shows low/increasing GDP and constant prices (due to spare capacity in the economy). The second shows increasing GDP with increasing prices due to terminated spare capacity. The third shows the level at which GDP cannot increase anymore as all resources have been employed at their maximum level (increases in output will only cause increases in price).

Question 19

Explain Equilibrium in the Keynesian Model

Answer 19

Determined by the point where the AD curve intersects the Keynesian AS. It can show:
• Deflationary gap when Ye < Yp
• Inflationary gap when Ye > Yp
• Full employment when Ye = Yp

Question 20

Explain the Role of Deflationary Gaps in the Keynesian Model

Answer 20

Deflationary gaps in the Keynesian model are not characterized by falling prices/ wages (due to factors such as minimum wage, labor contracts, price war fears, etc). This means the economy cannot move into the long-run when experiencing a deflationary gap, hence government intervention is necessary.

Question 21

What are the Determinants of LRAS (or Keynesian AS)?

Answer 21

• Quantity/quality of factors of production
• Technological innovations
• Changes in efficiency
• Institutional changes (e.g. competition)
• Changes in natural rate of unemployment