Unit 4 - Chapter 17 - Aggregate demand and aggregate supply Flashcards

Question

How does interset rate influence consumption?

Answer 1

**argumentment 1** A rise in the money supply leads to lower interest rate. A lower interest rate means the returns of savings and the cost of borrowing decrease. Households are more willing to spend rather than save as the OC of consumption drops. **argumentment 2** Also, they are more willing to borrow to buy expensive items such as housing, luxury holidays and cars.

Answer 2

(1) The cost of investment will fall. Firms that **borrow to buy capital goods will find it cheaper**. (2) Firms can save retained profits and earn interests. Alternatively, firms can use the retained profits to invest and expand output. As interest rate decreases, firms will find that **the opportunity cost of investment will fall, so they are more likely to invest rather than saving**. (3) Firms will also **expect higher sales** as lower interest rates will raise consumer demand. The likelihood of earning more profits encourages firms to expand.

Answer 3

1. Policy objectives 2. Size of tax base and budget position 3. Demographics 4. The type of economic system and the nature of markets 5. Unexpected events (shocks to the economy)

Answer 4

Policy objectives - If a government wants to raise economic activity, it may decide to raise its spending to ensure that aggregate demand is sufficient to achieve a high level of employment and an increase in the country’s output. - If a government wants to win political support, it may also decide to raise spending.

Answer 5

- Higher government tax revenue will enable a government to spend more, without needing to borrow - The government will be under pressure to cut spending (austerity) if it runs a big deficit.

Answer 6

Pressure for a rise in government spending may come from an increase in the number of children (education) and/or an increase in the number of elderly people (healthcare). Net immigration may increase the need to provide state-financed housing. However, immigrants of working age will provide tax revenue to finance the spending if some of the immigrants gain jobs in the country.

Answer 7

Government spending as a percentage of GDP is likely to be higher in countries where the government thinks there is significant risk of market failure. In such countries, governments are likely to provide, for example, state-financed education and healthcare. Government spending will be higher in planned economoy, as goods and services are allocated by the public sector.

Answer 8

A government will usually spend more after natural disasters, such as damage caused by a hurricane. It will also spend more during a military conflict. - For example, Eurozone governments raised spending significantly to counter the coronavirus crisis during 2020. Their combined budget deficits reached almost €1tn (€976bn), which represent a 10 times increase compared to 2019, and equal to 8.9% of GDP in 2020.

Answer 9

1. Relative price competitiveness 2. Quality competitiveness 3. Aggregate demand of domestic and foreign countries 4. Trade policies

Answer 10

For example, for the US, If the price of US goods is **relatievly** higher compared to other countries, and if the demand for US goods is price inelastic, then expenditure on US goods will **increase**. This is because the quantity demanded will decrease by a **smaller** percentage. As a result, **US exports hence NX** will increase P↑↑↑, Qd↓ ⇒ Expenditure (Revenue) ↑↑ _______________________________________ On the other hand, if the demand for US goods is price elastic, then expenditure on US goods will **decrease**. This is because the quantity demanded will decrease by a **greater** percentage. As a result, **US exports hence NX** will decrease P↑, Qd↓↓↓ ⇒ Expenditure (Revenue) ↓↓ _______________________________________ 记得把进口价格也说了 (higher US good price means imports become relatively cheaper) _______________________________________ The relative price of US goods will be more higher if there is 1. an increase in its exchange rate (international price of its currency) 2. higher inflation relative to foreign countries (domestic price of its currency) 3. higher cost of production OR lower productivity relative to foreign countries

Answer 11

An improvement in the competitiveness of the country’s products, due for example to innovations, improved marketing, increased investment and improved human capital will encourage exports

Answer 12

1. Home country’s GDP and foreign country’s GDPWhen a country’s GDP rises, demand for imports usually increases. Similarly, when incomes rise abroad, demand for the country’s exports is likely to increase. 2. Interest rate in domestic country and foreign country - For example, higher interest rate in a foreign country relative to the domestic country will cause the domestic currency to depreciate, as hot money in search of higher returns flows into foreign country. This will encourage exports and raise NX. - However, higher interest rate in a foreign country also dampen foreign consumption and foreign investment hence foreign GDP. This means the demand for the domestic country’s exports falls, damping NX. 3. Confidence 4. Wealth

Answer 13

(1) Trade restrictions (removal or imposition) (2) Export subsidies

Answer 14

1. **The profit effect (sticky wage):** As the price level (that is, the price of goods and services) increases, the price of factors of production such as wages do not change. So the price level rises, the gap between output and input prices widens and the amount of profit increases. 2. **The cost effect:** Although the wage rates and raw material costs remain unchanged in the short run, average costs may rise as output increases. This is because, for example, overtime payments may have to be paid and costs will be involved in recruiting more members. To cover any extra costs that may be involved in producing a higher output, producers will require higher prices. 3. **The misinterpretation effect**: Producers may confuse changes in the price level with changes in relative prices. They may think that a rise in the price they receive for their products indicates that their own product is becoming more popular. As a result they may be encouraged to produce more.

Answer 15

1. Production cost - Higher prices in factors of production (wages or raw material costs), SRAS shifts left. - Higher corporate tax rate or higher indirect tax rate, SRAS shifts up. - Higher expected inflation rate 2. Lower productivity

Answer 16

1. Production cost - Higher prices in factors of production (wages or raw material costs), SRAS shifts left. - Higher corporate tax rate or higher indirect tax rate, SRAS shifts up. - Higher expected inflation rate 2. Lower productivity - Deteriorated resource quality, e.g. more pollution so people are less healthier, malnutrition(营养不良) - Reduction in quantity of resources (supply-side shocks), e.g. natural disasters such as earthquakes and hurricanes

Answer 17

Keynesians often represent the LRAS curve as perfectly elastic at low rates of output, then upward sloping over a range of output and finally perfectly inelastic. This is to emphasize their view that, in the long run, an economy can operate at any level of output and not necessarily at full capacity (Y1). - Elastic段: When output and hence employment are low, firms can attract more resources without raising their prices. There is time for input prices to change but, due to the low level of aggregate demand, they do not. For example, when unemployment is high, the offer of a job may be sufficient to attract new workers. - Y to Y1 段: As output rises from Y to Y1, firms begin to experience shortages of inputs and bid up wages, raw material prices and the price of capital equipment. - Inelastic 段: When output reaches Y1, the economy is producing the maximum output it can make with existing resources.

Answer 18

The LRAS curve is a vertical line as the neoclassical economists believe thatiIn the long run the economy will operate at full capacity. People form rational expectation and the actual price level = expected inflation level

Answer 19

- **Net immigration**: Net immigration will increase the size of the labour force if the immigrants are of working age. - **An increase in the retirement age**: This will increase the size of the labour force. A number of countries have raised the age at which people can receive a state pension and some of these countries plan to raise it even further in the future as life expectancy increases. - **More women entering the labour force**: The proportion of women who work varies from country to country. For example, in 2020, only 21% of women of working age were in the labour force in Saudi Arabia, while in Norway the equivalent figure was 72%. - **Net investment:** If gross investment (total investment) exceeds depreciation (capital goods that have to be replaced because they have become worn out or out of date) there will be additions to the capital stock. - **Discovery of new resources**: The discovery of, for instance, new oil fields or gold mines can increase a country’s productive potential. - **Land reclamation (the creation of new land from the sea):** For instance, in recent years, Dubai has added considerably to its land area by reclaiming land on which it has built apartments, hotels, marinas, theme parks and beaches.

Answer 20

- **improved education and training** – this will increase the skills of workers and so raise labour productivity - **advances in technology** – these both reduce costs of production and increase productive capacity.

Answer 21

- 第一段：An equilibrium of an economy is when there is no tendency for the macro-economy to change. It occurs when the size of total expenditure, aggregate output and national income are equal to each other and they are stable. - 第二句：It can be illustread by the point where the AD and AS curves intersect, as illustrated below: (然后加上一个AS-AD的图） - 第二段：If the price level was initially below P0 at P1, there would be macro disequilibrium. The excess demand would push the price level back up to the equilibrium level. If the price level was above P0 at P2, some goods and services would not be sold and firms would have to cut their prices. （记得在你的图上面，画两条横线，一条在equilibrium price level P0上，一条在P0之下） - 第二句：the aggregate price level will adjust until it reaches P0, so P0 is the equilbrium price level, the corresponding output is the equilibrium output.

Answer 22

不一定。depends on PED of imports and exports.