2.2 + 2.3 (AD and AS)

Question 1

Why is the AD curve downwards sloping

Answer 1

1. interest rate effect (higher average price levels mean high interest rates which reduce investment)
2. Wealth effect: as average price level increases, purchasing power of households decreases and AD falls- and vise versa
3. Exchange rate effect : as AP falls, interest rates are likely to fall, consequently lowering the exchange rate , and increasing exports+real GDP

Question 2

when is there a shift in the AD curve

Answer 2

when there is a change in any of the determinants of AD in the economy

Question 3

what are transfer payments (Consumption)

Answer 3

a payment by the gov for which no goods/ services are recieved e.g unemployment benefits

Question 4

what happens to consumption when interest levels increase

Answer 4

• greater incentive to save
• less incentive to borrow
• loan and mortgage repayment cost increases
  > less consumption

Question 5

Discretionary income

Answer 5

disposable income - Mortgage interest rapayments

(discretionary income is reduced by high interest rates)

Question 6

positive wealth effect

Answer 6

Rising property prices or share prices give consumers confidence to borrow more money and spend

Question 7

net investment

Answer 7

total spending on capital goods - depreciation
( a better indication of extra production possibilities that have been created through investment by firms )

Question 8

The four key influences on the decision by firms to invest

Answer 8

• Rate of economic growth
  ( sends signal that higher output will generate higher profits )
• Interest rates
  ( inverse relationship )
• Demand for exports
  ( firms will likely invest to meet global demand, exports demand increases when exchange rate depreciates as goods seem cheaper to foreigners )
• Government and regulations
  ( subsidies increase I, regulation decreases I )

Question 9

Other influences on Investment (not key 4)

Answer 9

• Keynes and animal spirits
  ( belief that firms exhibit too much optimism in good times, taking more risks, making less rational investment decisions as they follow the herd )
• Access to credit ( loanable funds )

Question 10

Three biggest areas of gov expenditure in UK

Answer 10

• Social protection (welfare payments such as state pension, universal credit)
  £364.6 Billion in 2023-2024
• Health care services
  £222 Billion
• Education
  £113.1 Billion

2023-2024 statistics gov website

Question 11

Protectionism (net trade balance)

Answer 11

Governemnt policies that restrict international trade in order to protect domestic industries e.g import tarrifs (this influences net trade balance)

Question 12

effect on Net trade : UK real income increases

Answer 12

• little effect on exports
• consumers purchase more imports
• trade balance weakens

Question 13

Effect on Net trade : Real income increases abroad

Answer 13

• customers overseas purchase more UK products : exports increase
• Little effect on imports
• Trade balance strengthens

Question 14

Effect on Net trade : UK £ appreciates

Answer 14

• Exports more expensive for overseas consumers
• Uk consumers money goes further abroad : increase imports
• Trade balance weakens

Question 15

Effect on Net trade : UK £ depreciates

Answer 15

• Exports less expensive for customers overseas
• imports decrease, UK consumers money worth less abroad
• Trade balance strengthens

Question 16

Effect on Net trade : World economy booms

Answer 16

• Increased demand for UK exports
• Little effect on imports
• Trade balance strengthens

Question 17

Effect on Net trade : World economy slows

Answer 17

• Decreased demand for UK exports
• Little effect on imports
• Trade balance weakens

Question 18

Effect on Net trade : Protectionism increases

Answer 18

• Effect on Exports depends on retaliation measures from other countries
• Decreased demand for imports
• Trade balance strengthens

Question 19

What is the weakening/strengthening of the trade balance dependent on as a result of exchange rate changes?

Answer 19

the PED of exports and imports
- explained by the J curve and Marshall Lerner Condition

Question 20

Marshall-Lerner Condition

Answer 20

Depreciation/devaluation of countrys currency will lead to an improvememnt in its net trade balance only if the sum of the PED of its imports/exports is >1

Question 21

J curve

Answer 21

Argues that a net trade balance will worsen in the short term after a currency devaluation, but improve in medium to long term.

Question 22

Movement / shift of SRAS curve

Answer 22

Movement = change in average price level
Shift = change in conditions of supply

Question 23

The relationship between SRAS and LRAS

Answer 23

• SRAS is influenced by changes in cost of production over a period of time where at least one FoP is fixed
• LRAS is influenced by a change in the productive capacity of the economy (PPF)
• long term economic growth requires productive capacity to increase

Question 24

effect of appreciation in exchange rates on SRAS

Answer 24

stronger currency = cheaper imports
decrease in input costs
SRAS shifts to right

Question 25

effect of depreciation in exchange rates on SRAS

Answer 25

weaker currency = more expensive imports increase in input costs SRAS shifts left

Question 26

CLassical LRAS view

Answer 26

In the long run, an economy will always return to full level of output - Perfectly inelastic (vertical) at point of full employment of all available resources

Question 27

Keynesian LRAS view

Answer 27

Supply is elastic at lower levels of output as there is lots of spare capacity in economy. Supply is perfectly inelastic at point of full employment = increased price inflation as firms compete for scarce resources

Question 28

Factors influencing LRAS

Answer 28

- technological advances - changes in relative productivity - changes in education and skills - changes in government regulations - demographic changes and migration - competition policy (regulation to prevent monopoly)