AD and AS and Equilibrium

Question 1

What is AD?

Answer 1

Total spending on goods and services produced in the domestic economy over a given period of time.

Question 2

AD Curve?

Answer 2

Slopes downwards as there is an inverse relationship between AD and the price level.

Question 3

Why does AD curve slope down?Wealth

Answer 3

Wealth effect-lower price level results in wealth having a greater purchasing power(stock of accumulated assets) so spending increases as consumers feel wealthier.

Question 4

Why does AD curve slope down?Trade

Answer 4

A higher domestic price level all other things being equal reduces the international price competitiveness of domestic producers.Less consumption on exports leading to a fall in AD.More spending on imports.

Question 5

Why does AD curve slope down?IR

Answer 5

When the price level is high more money is needed for economic transactions.Therefore economic agents need to borrow more.If the interest rates are relatively high cost of borrowing rises so consumers are less likely to borrow and instead save their money.C and I fall

Question 6

Causes of increases in AD?Reductions is just the opposite

Answer 6

Increase in Consumer confidence,Business optimism,Fall in taxation,Increase in money supply,reduction in interest rates ,fall in exchange rate,increase in wealth,Increased gov expenditure

Question 7

What is AS?

Answer 7

The total output of domestically produced goods and services that firms are willing and able to supply at a given price level in an economy over a given period of time.

Question 8

Short-run Vs Long-run

Answer 8

Short run is the period of time where the price of at least one factor input is fixed.Long run is the period of time where the price of factor inputs are variable.

Question 9

Relationship between SRAS and Price-Level?

Answer 9

Positive relationship between SRAS and the price level.This is because firm can cover any extra wage costs and increase output at a higher price level and they are incentivised to extend supply as their profit margin is likely to rise.

Question 10

Factors affecting SRAS

Answer 10

Changes in labour costs-wage costs adjusted for productivity.An increase maybe due to higher wages or fall in productivity reducing SRAS.Changes to raw material prices.Changes in other costs of production.Exchange rates an increase will increase SRAS

Question 11

More factors affecting SRAS

Answer 11

Taxation and subsidies,Price of imports and short run shocks to production.

Question 12

Increases in SRAS

Answer 12

Reduction in unit labour costs,lower costs of finance,lower administration costs.

Question 13

What is Short run macroeconomic equilibrium?

Answer 13

When AD=AS.The real output produced by firms in the economy is exactly equal to the total demand for goods and services produced in the economy.At output y1 there is no inflationary or deflationary pressure on the price level.

Question 14

What is the potential output of an economy determined by?

Answer 14

Quantity and quality of factors of production.Mobility of factors occupational and geographical mobility of factors.State of technological progress.Neoclassical LRAS is perfectly inelastic.

Question 15

What do Neoclassical economists believe in the long run?

Answer 15

They believe that in the long run the LRAS curve is independent of the price level.The position of the vertical LRAS represents the full capacity level of output of an economy.In the long run the economy will always move to its full employment level of output which is where the AD curve meets the LRAS (Long run equilibrium level of output)Curve.

Question 16

Describe shape of Keynesian LRAS Curve

Answer 16

Section 1-Spare capacity.If output is low enough the economy will have loads of spare capacity.Resources are not being fully utilised so an increase in output in response to AD leading to more factors being employed will not push up the factor prices as spare factors can be utilised in production leading to an increase in Real GDP with no increase in price level.

Question 17

Stage 2 of Keynesian LRAS Curve

Answer 17

Increasing scarcity.Factor prices start to rise as output increases so the price level start to rise as firms compete for factor inputs.The national output firms are williang able to supply goes up but due to increasing pressure on factor prices to rise the average price level rises.

Question 18

Stage 3 of Keynes

Answer 18

Full capacity.If output is high enough the economy will reach its full employment level of output.Factors of production are fully utilised and any increase in output will lead to factor prices being pushed up as there is no spare capcity.Leads to an increase in price level and no increase in real national output in long run.

Question 19

What is long run economic growth?

Answer 19

Increase in productive capacity of an economy in the long run.Increase in potential output of an economy.

Question 20

Causes of long run economic growth?

Answer 20

Increase in quality or quality of factors of production.Improvement in tech.Increase in entrepreneurs. Increased mobility of workforce.

Question 21

What does a highly effective institutional structure contain?

Answer 21

Stable and democratic political system
Very well functioning legal system
Effective and efficient financial system.

Question 22

How is a highly effective institutional structure useful.

Answer 22

Entreprenurs are much more likely to undertake economic activity as they are more likely to be able to earn profits for risk taking.Sustained private investment is likely to be more influential in providing long run growth due to a more stable economic environment.Increases in productive capacity are likely to occur over time as private oweners of capital are more likely to undertake investment and re invest with the profits earned.

Question 23

What is the accelerator effect?

Answer 23

An increase in rate of growth can lead to a much larger proportional increase in investment further accelerating increases in national income.The rate of investment depends on the rate of growth so it is very volatile.

Question 24

When will firms only replace worn out capital?

Answer 24

If the same products and the same amount of products are produced each year only replacement investment is needed.

Question 25

What happens to investment if there is expected to be an expansion in economic activity?

Answer 25

If there is expected to be an expansion in economic activity firms are incentivised to acquire additional capital induced investment.To be able to meet the new additional total demand.To produce the additional goods and services required.

Question 26

What happens to investment when there is a contraction in economic activity?

Answer 26

Firms are unlikely to acquire any new capital no induced investment as demand is expected to fall.They will not buy replacement capital if they have sufficient existing capacity.

Question 27

What happens to investment when there is a fall in the rate of growth?

Answer 27

Firms are still incentivised to acquire replacement capital but there will be less induced investment as demand is rising at a slower rate.There will be a fall in rate of investment when economic growth slows down.

Question 28

Why is investment more volatile than national income?

Answer 28

Investment has the tendency to rise proportionally faster when there is an increase in the rate of growth.Investment expenditure rises at a faster rate than the rate of growth accelerating the increase in national income.
Investment will fall even when the output is increasing if the growth rate falls.
If real national output is constant, investment will be limited to replacement investment only.
If national output falls even slightly investment can be wiped out completely.If no replacement investment is required.

Question 29

Why is the value of the capital greater than the value of its output per year?

Answer 29

Because capital goods are durable goods and produce for many years.Marginal capital output ration=changeinK/change in Y 4 millon of induced investment is required to produce the additional annual 2 million pounds of products demanded.If ratio =2

Question 30

Accelerator effect assumptions

Answer 30

Firms annual investment decisions are based on level of investment required to meet forecasted additional total demand.
Firms using existing marginal capital ratio to determine the level of investment required to meet the additional total demand.

Question 31

What increases the value of the accelerator?

Answer 31

The greater the durability of the capital the greater the value of the accelerator and the greater the value of the acceleration effect.Same for a higher capital output ration

Question 32

Evaluate the acclerator

Answer 32

Accelerator effect is difficult to predict because:
Many firms have existing spare capacity so they may not have increase investment in order to meet additional demand.
The willingness of firms to invest will depend on expectations of future demand.
Firms may plan investment over longer periods of time and may not be able to increase investment immediately
Costs of finance

Question 33

When does a positive output gap occur?

Answer 33

When the short run equilibrium level of GDP/Output is above full capacity due to excess AD.Can only persist in short run in long run economy will return to potential output.Factor prices rise to reduce sras in long run.Causing the price level to rise.

Question 34

When does a negative output gap occur?

Answer 34

When the short run equilibrium level of GDP/Output is below full capacity. due to insufficient AD.Can only persist in short run in long run economy will return to potential output.Factor prices will adjust to increase SRAS in the long run.In the long run only affect is to push down price.

Question 35

What is an economic cycle?

Answer 35

The natural variation in economic activity and actual output in an economy over a given period of time.

Question 36

Describe phases of an economic cycle.

Answer 36

Recession(Fall in GDP for 2 consecutive quarters)-Falling
Real Gdp,Falling employment.

Recovery-Increasing output,falling unemployment.Economy still has negative output gap.

Boom-Real GDP increasing at a faster rate than trend rate of growth.Actual output rising faster than potential output usually accompanied by increasing employment.Unemployment could fall below the natural rate.Increasing inflation,the economy experiences a positive gap where actual output is above potential output.

Slowdown-Slower growth could be accompanied by increasing unemployment.Positive output gap is reduced and actual growth is slower than potential growth eliminating positive output gap.