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Macro: AD-AS Flashcards

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1
Q

What does the circular flow of income model illustrate?

A

The flow of income between households and firms and the exchange of factors between them

This model shows how households supply labor to firms in exchange for wages, which are then spent on goods and services.

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2
Q

What are injections in the circular flow of income?

A

Additions to the circular flow that increase national income, such as:
* Money spent by foreign citizens on exports
* Investment spending by firms on new capital
* Government spending

Injections contribute positively to the economy’s overall income.

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3
Q

What are leakages in the circular flow of income?

A

Reductions to the circular flow that decrease national income, including:
* Money spent on imports
* Money saved by individuals and firms
* Taxation

Leakages take money out of the economy, affecting overall income.

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4
Q

What happens if total value of injections is greater than total value of leakages?

A

There will be an expansion of national income.

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5
Q

What happens if total value of injections is less than total value of leakages?

A

There will be a contraction in national income.

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6
Q

What is aggregate demand (AD)?

A

The total of all planned expenditures in the economy, calculated as:
* Consumption (C)
* Investment (I)
* Government Spending (G)
* Net Exports (X - M)

AD reflects the total spending in the economy over a period.

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7
Q

What are the components of aggregate demand?

A

The components of aggregate demand are:
* Consumption (C)
* Investment (I)
* Government Spending (G)
* Net Exports (X - M)

These components help to analyze the overall economic activity.

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8
Q

What is the formula for aggregate demand?

A

AD = C + I + G + (X - M)

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9
Q

What effect does an increase in consumption have on aggregate demand?

A

AD will increase and shift out to the right.

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10
Q

List factors that may cause an increase in consumption.

A
  • Reduction in income taxes
  • Increase in benefits
  • Reduction in interest rates
  • Increase in wealth
  • Increase consumer confidence

These factors contribute to higher household spending.

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11
Q

What happens to aggregate demand if government spending increases?

A

AD will increase and shift out to the right.

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12
Q

List factors that may cause an increase in government spending.

A
  • Policies to spend more on defense, education, road building, healthcare, housing
  • Ageing population
  • Rise in pollution levels

These factors may prompt governments to allocate more funds.

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13
Q

What happens to aggregate demand if investment increases?

A

AD will increase and shift out to the right.

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14
Q

List factors that may cause an increase in investment.

A
  • Increased business confidence
  • A fall in interest rates
  • Advances in new technology
  • Reduction in corporation tax

These factors encourage businesses to invest more in capital goods.

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15
Q

What are net exports?

A

The difference between the value of exports (X) and the value of imports (M).

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16
Q

What happens to aggregate demand if net exports increase?

A

AD will increase and shift out to the right.

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17
Q

List factors that may cause an increase in net exports.

A
  • Fall in £ exchange rate
  • Rise in income in other countries
  • Better competitiveness of UK goods

These factors can enhance demand for UK exports.

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18
Q

Why does the aggregate demand (AD) curve slope downwards?

A

An increase in the price level reduces Real GDP due to:
* Real Balance Effect
* Trade Effect
* Interest Rate Effect

Each effect describes how rising prices can lead to lower consumption, exports, and investment.

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19
Q

What is consumption?

A

The total spending of UK households on goods and services for their own private use, which is an injection to the circular flow.

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20
Q

What factors may cause consumption to increase?

A
  • Interest rates reduced
  • Income tax reduced
  • Real incomes increase
  • Consumer confidence increases
  • Fall in unemployment
  • Positive wealth effect
  • Savings ratio decreases

These factors can significantly boost household spending.

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21
Q

What is the savings ratio?

A

The level of household saving as a percentage of household disposable income.

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22
Q

List reasons why people save.

A
  • Precautionary reasons
  • Building up potential spending power
  • Interest rates
  • Life-cycle reasons

These reasons illustrate the motivations behind saving behavior.

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23
Q

What is Gross Investment?

A

Spending on capital goods/assets (e.g. factories and machinery) by businesses that creates future production capacity

Gross Investment is an injection to the circular flow of the economy.

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24
Q

How does an increase in Gross Investment affect Aggregate Demand (AD)?

A

AD will increase and shift out to the right, ceteris paribus

This indicates a positive relationship between investment and aggregate demand.

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25
What is Net Investment?
Gross investment minus depreciation of capital assets ## Footnote Net Investment provides a more realistic picture of the quality of a nation’s capital assets.
26
What causes capital assets to depreciate?
Wear and tear over their lifetime ## Footnote Depreciation reduces the productivity of capital assets.
27
List factors that may cause investment to increase.
* Consumer demand increases * Interest rates are reduced * Access to credit is made easier * Corporation tax is reduced * Government regulations on businesses are reduced * Demand for exports increases * Businesses feel more confident about future consumer demand * 'Animal Spirits' (gut instinct) ## Footnote These factors influence business decisions regarding investment.
28
What is the 'Animal Spirits' concept in investment decisions?
Investment decisions based on gut instinct rather than rational analysis ## Footnote Introduced by John Maynard Keynes, it highlights the psychological factors influencing investment.
29
True or False: Investment is only about 20% of aggregate expenditure but can fluctuate significantly.
True ## Footnote The variability is influenced by business confidence regarding future sales.
30
What is the accelerator effect?
Investment levels are determined not by the absolute level of output, but by the rate of change in output. ## Footnote During economic growth, investment tends to grow faster than national output.
31
What is Government Spending (G)?
Spending by the government on capital goods and services such as schools, hospitals, and infrastructure ## Footnote It is an injection into the circular flow of the economy.
32
What does Government Spending not include?
Benefit payments such as Jobseeker's Allowance (JSA) and pensions ## Footnote These are considered transfer payments to consumers and counted as consumption.
33
List factors that may cause government spending to increase.
* The objectives of the government in power * The current economic situation ## Footnote For example, the Labour Party typically spends more than the Conservative Party.
34
How can government spending create long-term benefits?
By improving the quality of the factors of production capacity ## Footnote Examples include spending on education and healthcare.
35
What are Net Exports?
The value of exports (X) minus the value of imports (M): (X-M) ## Footnote Exports are an injection, while imports are a leakage from the circular flow.
36
What may cause exports to increase?
* Depreciation of the pound * Increase in UK productivity * Growth in overseas consumer demand * Improvement in the quality of UK goods ## Footnote These factors enhance the competitiveness of UK exports.
37
What may cause imports to increase?
* Increase in UK consumer demand * Higher UK inflation * Appreciation of the pound * Preferable quality of imported goods ## Footnote These factors make imports more attractive to consumers.
38
True or False: The UK economy usually runs a substantial trade surplus.
False ## Footnote The UK typically runs a trade deficit, which negatively contributes to AD.
39
What is Aggregate Supply?
The total of all planned production in the economy at each price level ## Footnote It reflects the total output of goods and services at different price levels.
40
Define Short-Run Aggregate Supply (SRAS).
Total planned production when prices can change but at least one factor of production is fixed ## Footnote It is represented by an upwards sloping curve.
41
What happens to SRAS when the Price Level increases?
It causes an increase in SRAS ## Footnote Higher prices lead firms to increase output, incurring higher costs.
42
What is the relationship between Real GDP and Price Level in SRAS?
Higher output is associated with a higher average price level ## Footnote Conversely, a reduction in output leads to a fall in the average price level.
43
What does a change in the average price level indicate?
Changes in Real GDP and a movement along the SRAS curve
44
What happens when any factor affecting the SRAS changes?
It causes a shift in the SRAS curve
45
What will happen to Real GDP if there is a shift in the SRAS curve?
It will be either higher or lower at the same price level
46
What is illustrated by a shift in the Short-Run Aggregate Supply Curve?
The change in supply at the same price level
47
What are the main factors that cause shifts in the SRAS curve?
Supply-side shocks
48
What do supply-side shocks refer to?
Sudden changes to the cost of production for firms in an economy
49
What effect does a decrease in the cost of production have on supply?
It increases supply
50
What effect does an increase in the cost of production have on supply?
It decreases supply
51
What is one main source of supply-side shocks?
A change in wage rates in an economy
52
How does a change in wage rates affect firms?
It increases the wage bill and costs, leading firms to raise prices
53
What is another source of supply-side shocks?
A change in the costs of raw materials
54
How do changes in the price of oil affect the SRAS curve?
If oil prices rise, SRAS shifts to the left; if they fall, SRAS shifts to the right
55
What effect does a strengthening currency have on import prices?
It makes imports cheaper, shifting SRAS to the right
56
What happens to SRAS when a currency weakens?
It shifts to the left as imports get more expensive
57
What is the impact of changes in government indirect taxes on SRAS?
They can either increase or decrease supply, shifting SRAS
58
Fill in the blank: A change in wage rates leads to an increase in the ______.
wage bill
59
True or False: A decrease in raw material costs will shift the SRAS curve to the left.
False
60
Show an inwards and outwards shift in SRAS
61
Show and explain Macroeconomic Equilibrium in the short-run
Hence AS1 intersects the AD curve at P1, Y1. So reduction in iron ore has reduced both the price level in the economy and increased Real GDP. Here the output produced by the economy is exactly to the total demand in the economy so there is no upward or downward pressure on the price level.
62
Show and explain Short-run Macroeconomic equilibrium when there is a shift right in SRAS.
If there is a decrease in the price of iron ore this will reduce the cost of production for firms. As their costs fall they will decrease their prices. This will cause the AS curve to shift to the right from AS-AS1 Hence AS1 intersects the AD curve at P1, Y1. So reduction in iron ore has reduced both the price level in the economy and increased Real GDP.
63
Show and explain Short-run Macroeconomic equilibrium when there is an inwards shift in AD
If there is a decrease in consumer confidence in the economy consumption spending will fall. Since AD = C+I+G=(X-M) this will lead to a fall in AD from AD Hence AD1 intersects the AS curve at P1, Y1. So reduction in consumer confidence has reduced both the price level in the economy and decreased Real GDP.
64
What is the effect of boosting government spending on Real GDP?
It shifts AD from AD1 to AD2, causing an increase in Real GDP from Yfe to Y1. ## Footnote This increase is a result of higher aggregate demand due to government spending.
65
What happens to the Price Level when government spending increases?
The Price Level increases from P to P1. ## Footnote This increase in demand leads to higher prices in the economy.
66
How does an increase in the Price Level affect firms?
Firms face higher costs for factors of production, including wages and raw materials. ## Footnote This increase in costs forces firms to adjust their production strategies.
67
What is the result of firms facing higher production costs?
The SRAS shifts to the left, reducing Real GDP and further increasing the Price Level. ## Footnote This shift indicates a decrease in short-run aggregate supply.
68
What is the long-run outcome of shifts in AD or SRAS?
The economy returns to the LRAS of Yfe, with only the Price Level having changed. ## Footnote This reflects the self-correcting nature of the economy in the long run.
69
According to the Classical Model, what policies can increase Real GDP?
Policies that improve the quality or quantity of the factors of production. ## Footnote This model emphasizes the importance of supply-side factors in economic growth.
70
Fill in the blank: An increase in demand causes the SRAS to shift to the _______.
left ## Footnote This shift indicates a decrease in short-run aggregate supply due to rising costs.
71
True or False: In the long run, the economy will always return to Yfe regardless of short-run shifts.
True ## Footnote This is a fundamental principle of the Classical Model.
72
What does the shift from AD1 to AD2 represent?
An increase in aggregate demand due to government spending. ## Footnote This shift is essential for understanding the impact of fiscal policy on the economy.
73
What is the initial change in Real GDP when AD shifts from AD1 to AD2?
It increases from Yfe to Y1. ## Footnote This increase illustrates the immediate effect of government spending on economic output.
74
Show an outwards shift in PPF
75
Show an outwards shift in LRAS
76
What do Keynesian economists believe about market power?
Keynesian economists are less optimistic about the power of markets.
77
Why do Keynesian economists think markets frequently do not clear?
Because firms do not just compete on price and workers are reluctant to accept wage cuts.
78
What happens when aggregate demand (AD) suddenly falls due to 'animal spirits'?
Demand will fall as consumption falls.
79
What is a consequence of a fall in aggregate demand according to Keynesian economists?
The price level will not fall enough to encourage households and firms to start spending again.
80
What can happen to the economy when it gets stuck at a lower level of output?
It may remain at this lower level of output for prolonged periods of time.
81
What is the Keynesian perspective on the verticality of the AS curve?
The AS curve becomes vertical when the economy is at full employment.
82
Fill in the blank: Keynesian economists believe that _______ and _______ are not flexible enough.
prices ## Footnote Wages
83
True or False: Keynesian economists believe that markets always clear.
False.
84
What happens to the economy if AD suddenly falls due to 'animal spirits'?
Demand will fall as consumption falls, and the economy may get stuck at a lower output level than full employment.
85
What characterizes the AS curve at low levels of GDP?
The AS curve is very elastic, allowing increases in output with only small increases in inflation.
86
What does 0 – Y1 represent in economic terms?
An economy producing well inside its PPF with significant unemployment of resources.
87
What occurs as GDP increases from Y1 to Yfe?
Some resources may be unemployed, leading to supply constraints and higher production costs.
88
What happens to the AS curve as the economy moves close to full employment?
The AS curve becomes increasingly inelastic (steeper).
89
What is the relationship between spending increases and output at the Y1 to Yfe stage?
Any increase in spending will create inflation but only small increases in output.
90
What is the significance of Yfe in economic terms?
It represents full employment with no spare capacity.
91
What does the AS curve look like at full employment (Yfe)?
The AS curve is perfectly inelastic, meaning output cannot increase.
92
What must happen for long-term output increases in an economy at full employment?
There must be technological changes and increases in the stock of capital.
93
Fill in the blank: At high levels of real GDP, the economy is at _______.
[full employment]
94
True or False: At Yfe, the price level can rise but output cannot.
True
95
What does Y1 correspond to in terms of the production possibilities frontier (PPF)?
An economy moving closer to the boundary of its PPF.
96
Lable and draw the THE KEYNESIAN AGGREGATE SUPPLY CURVE. What does each stage representation ?
97
Show a Long-Run Shifts in the Keynesian AS Curve
Like the Classical Model shifts in the Keynesian LRAS are caused by changes in the quality and quantity of the factors of production. If they improve then if all the factors of production are fully employed then Yfe will increase. In the diagram above this would be represented by a shift in AS from AS1-AS2. If there were to be a civil war or a natural disaster then Yfe would be reduced. This would be represented by a shift in AS from AS1-AS3.
98
What does the Multiplier measure?
The knock on effects when there is an injection or withdrawal in the economy
99
What does a small change in aggregate demand lead to?
A larger or multiplied effect on AD and GDP
100
Give an example of an injection in the economy.
The government builds a school
101
What happens to money during the multiplier effect?
It flows around the economy a number of times, adding to GDP each time
102
How does the multiplier effect begin?
With an initial injection into the circular flow
103
What do builders do with the money they earn from building schools?
They take the money home and spend some of it on consumption
104
What is a potential way builders might spend their money?
Going to the pub
105
What does the money spent at the pub contribute to?
The income of the bar staff
106
What do bar staff do with their wages?
They take it home and spend it on shopping, etc.
107
What is the overall result of the multiplier effect?
A proportionally greater increase in AD

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