3.1 Introduction to Macroeconomics

• Effect of increase equilibrium (short run)

  Effect on national income: Facing an increase in AD, firms will increase output by entering the factor market to demand more factors of production, including labour, paying out more factor income. Through the multiplier process where spending creates income and income generates more spending, AD eventually increases from AD0 to AD1, causing real national income to increase from Y0 to Y1, towards the full employment level of national income Yf. In the process, employment also increases.** Assume there exists spare capacity in the economy output
• Effect on increase of equilibrium (short run)

  Effect on GPL:As firms enter the factor market to demand for more fop, holding factor supply constant, the increase competition for fop bids up factor prices. This increases the unit cost of production and firms, to protect their profits,will pass on part of the higher cost by raising prices of final g & s.
• Fator affecting extent of change of real national income and GPL (short run)

  1. availability of spare capacity

  • The greater the available spare capacity, the more easily firms can increase output without having to bid up prices of factor inputs, allowing real national income to increase by a larger magnitude without causing a sharp increase in the prices of final goods and services (or GPL).
• Factors affecting extent of change of real national income and GPL (short run)

  2. leakages

  • Where leakages are high, a large % of every additional dollar of income earned will leave the circular flow of income, with less channelled back to create income for the next group of households in the economy, weakening the multiplier effect, resulting in a smaller overall increase in real national income than if leakages were smaller.
• Define aggregate demand:

  Aggregate demand refers to the quantity of domestically-produced goods and services that households, firms, government and foreigners are willing and able to buy at each possible general price level. It excludes quantity of imports demanded.

  AD = C + I + G + X - M

  C = consumer expenditure

  I = investment

  G = Government expenditure

  X-M = Net exports
• Define consumer expenditure (C):

  Consumption is the act of using income for the purchase of goods and services to satisfy current needs and wants
• Define Investment (I):

  1. Fixed capital formation is the acquisition of new capital goods, which are used as factor inputs to produce other goods and services.
  2. Firm hold some inventories to meet any unexpected increase in demand for their goods
• Define fiscal policy:

  Fiscal policy is the deliberate manipulation of government expenditure and taxes to promote macroeconomic growth like full employment, price stability and economic growth
• Define monetary policy:


  Monetary policy is the deliberate attempt by the Central Bank to regulate the money supply or manipulate the interest rate to influence the level of economic activity to achieve economic objectives such as maintaining full employment, curbing inflation, attaining economic growth, and a satisfactory balance of payments position.
• Define aggregate supply:

  Aggregate supply refers to the quantity of domestically-produced goods and services that firms are willing and able to supply at each possible general price level
• Effect on increase in equilibrium (long run)


  The expansion of the productive capacity enables the economy to expand output to meet the increase in AD.

  An increase in AD from AD0 to AD1, holding AS constant at AS0, while raising real national income from Y0 to Y1, also brings about sharp inflation with GPL increase from P0 to P1. With the expansion of productive capacity, AS increases from AS0 to AS1. This allows real national income to increase past the original full-employment income level to Y2 while moderating inflation (without GPL increasing only by P0P2 instead of P0P1)