THEME 2

• What is aggregate demand?

  Total spending on goods and services in an economy.
• What are the four components that make aggregrate demand?

  Consumption, investment, government spending, and net exports.
• What is the formula for aggrergate demand?

  AD = C + I + G + (X - M)
• Why does the AD curve slope downwards?

  Aggregate demand (AD) curve slopes downwards because as the price level decreases, the real wealth of households increases, leading to higher consumption and higher aggregate demand.
• What affects AD to be downsloping?

  Aggregate demand (AD) is downsloping due to the wealth effect, interest rate effect, and international trade effect.
• What is investment?

  spending by firms of capital goods resulting in an increase in the capital stock.
• What is gross investment?


  the total addition to capital stock.
• What is net investment?

  gross investment - depreciation.
• What does an increase in interest rate mean?

  An increase in IR, will increase costs of borrowing. This will lead to firms being unable to access loans from banks as a much cheaper cost. Thus, decreasing investment.
• what does an increase in interest rate do as a positive?

  An increase in IR, will also increase the incentive to save, thus more people will consume goods + services. This will lead to businesses in spending less in capital stock to fulfill the decreased demand.
• Most imported goods are normal goods. Explain this statement?

  Qd for imports has a positive relation with changes in income. Income increases demand for imports increases
• What is the impact of stronger currency?

  exports become more expensive—-> demand for exports falls—-> total value of exports fall.
• What is the impact of stronger currency on imports?

  imports become cheaper—-> demand for imports rises—-> total value of imports increases
• Lower X and higher M—-> increase in (X-M)
• What are factors that affect net trade?

  • changes in real income (domestically and abroad)
  • changes in exchange rates
  • changes in protectionist policies
  • non-price factors
• What is government expenditure?

  Spending by the government on goods, services, and programs.
• There is an inverse relationship between net trade and exchange rate.
• Why is the short run aggregate supply curve upward sloping?

  in short run, resource prices are fixed—>firms costs are fixed. If price rises firms will make more profit on each unit they produce—->they are willing to produce more and the economies output increases.
• Explain why Keynesian LRAS curve has a bended shape?

  wages are sticky downwards therefore in a recession when there’s a mass unemployment, the level of output could increase without any inflationary pressure by utilising the space capacity in economy.

  ,
• What benefits of economic growth?

  higherdisposable income

  high employment

  high profits for firms

  fiscal dividend for governments
• What costs for economic growth?

  inflation, income inequality, one sector dominates, capital intervenes, rural versus urban, poor quality jobs, lack of welfare states
• Why is the Keynesian phase horizontal?

  It is horizontal as firms cannot reduce prices as costs are fixed. cannot set price below that so it’s horizontal.
• Why is the classical phase vertical?

  Classical LRAS has a vertical shape. When AD increases or decreases temporarily SRAS will shift back adjusting for the changes in the cost of production. This acts as an automatic correction mechanism.
• What is aggregate supply?

  The total amount of goods and services firms will supply at various price levels.
• What are the two versions of aggregate supply?

  classical aggregate supply and Keynesian aggregate supply
• Why is the SRAS curve upward sloping ?

  Short run resources prices are fixed. This means that firms costs Are fixed. As a result, if price rise then firms will make more profits on each unit they produce. As a result, they are willing to produce more and the economy’s output increases.
• The new classical LRAS curve is vertical at the full employment level of output.
• What does yf stand for?

  potential output
• What is full employment level of output?


  This is the level of output (rGDP) that an economy could produce if was using all of its factors of production at sustainable levels. Economy’s maximum potential real GDP.
• What is positive output gap?

  occurs when an economy’s rGDP exceeds maximum potential rGDP.
• What is negative output gap?

  Occurs when an economy’s rGDP is less than maximum potential rGDP.
• Explain how inflation is measured in the Uk?

  Inflation is measured by using a price index such as CPI (consumer price index). CPI is calculated on a monthly basis by collecting 700 goods approximately known has a shopping basket. The price of these goods are collected. A weighted average of price change is calculated as the data is then converted Into index form.
• What is inflation?

  the sustained increase in the average price level
• What is price level?

  the average levels of prices in an economy.
• What is disinflation?

  occurs when the rate of inflation decreases.
• What is deflation?

  is a sustained decrease in the average price level.
• What is the multiplier?

  when an injection into the circular flow leads to a greater increase in AD and rGDP.
• What is the formula for multiplier?

  1/MPW
• What is the formula for multiplier in a two sector model?

  1/1-MPC
• What is the formula for multiplier in a five sector model?

  1/MPS+ MPT+MPM