Revision 2.0

Question 1

Factors that Shift AD

Answer 1

1. Consumer confidence or income: positive correlation
2. Interest rates and monetary policy: negative correlation
3. Fiscal policy outlook: positive correlation
4. Exchange rates and foreign demand: depreciation cause increased AD

Question 2

Transmission Mechanism- AD

Answer 2

1. Wealth Effect: P rises -> depreciation of AUD -> real wealth falls -> C falls -> AD falls
2. IR Effect: P rises -> depreciation of AUD -> increased borrowing -> increased demand for borrowing -> rise in IR’s -> discourages investment spending -> AD falls
3. Exchange Rate Effect: P rises -> higher IR’s -> attracts foreign investment -> NX fall -> AD falls

Question 3

LRAS Shifts

Answer 3

1. Natural Rate of UE
2. Natural Rate of Output
3. Physical/human capital
4. Natural resources
5. Technology

Question 4

Sticky Wage Theory

Answer 4

Fixed wages based on Pe -> Actual P greater than Pe -> real wages fall -> labour gets cheaper -> firms hire more -> output (Y) rises

Question 5

Sticky Price Theory

Answer 5

Prices set by Pe -> MS increases -> Actual P rises -> firms w/o menu costs increase P immediately -> firms w/ menu cost keep P low temporarily -> their goods are cheaper -> demand for their goods rise -> increase output and workers

Question 6

Misperception Theory

Answer 6

Actual P rise above Pe -> firms mistakenly think their P rise due to rise in demand -> they increase output -> rise in employment

Question 7

Contractionary MP

Answer 7

Contractionary MP -> RBA sells government bonds to banks -> less MS on STMM -> increases demand for money -> competition b/w banks to access limited funds rises -> cost of borrowing becomes more expensive (as banks charge each other higher IR’s) -> increased cash rate -> increased IR’s -> greater attraction from foreign investors -> foreign investors must convert their money into AUD -> appreciated AUD -> import inflation falls -> less import prices + greater export prices -> less inflation + less eco growth

Question 8

Contractionary FP

Answer 8

Contractionary FP -> rise in taxes/fall in govt. spending -> decreased AD from decreased disposable income/decreased govt. demand for g/s -> decreased firm production + hiring -> fall in inflation, fall in GDP and rise in UE

Question 9

The Crowding-Out Effect

Answer 9

Fiscal Expansion -> raises IR’s -> reduce investment -> reduces the net increase in aggregate demand -> size of AD shift may be smaller than the initial fiscal expansion

Question 10

The Multiplier Effect

Answer 10

Govt. Spending -> income rising -> rise in consumption -> income of of sellers to rise -> more spending

Question 11

Risks of Expansionary FP

Answer 11

Risks:
Increased budget deficit
Resign govt. debt
Possible inflation if economy is already near full capacity