10.4

• Which factors influence the level of of economics activity?

  • employment
  • Confidence
  • Events
  • Other factors
• how does employment influence the level of economics activity?

  influences production and consumption
• how does confidence influence the level of economic activity?

  influences the level of spending and investment
• how do events influence the level of economic activity?

  natural disasters or Christmas influence the level of consumer spending
• how can other factors influence the level of economic activity?

  taxes and interest rates influence how much firms and consumer borrow, save or spend
• multiplier definition

  the relationship between a change in aggregate demand and the resulting generally larger change in national income
• How does a rise in AD affect the level of economic activity in the short run?

  • higher output (GDP)
  • Lower unemployment
  • Potential demand-pull inflation if economy near capacity
• what determines the multiplier effect in relation to AD?

  • size of injections vs withdrawals
  • marginal propensity to consume (MPC) - higher MPC = bigger multiplier
  • strength of confidence in economy
• why might the multiplier effect be weaker in reality ?

  • higher marginal propensity to import
  • high marginal propensity to save
  • supply-side constraints (e.g labour shortages)
  • leakage of income through taxes
• What is the equation for the multiplier?

  Change in national income/initial change in government spending
• Marginal propensity to consume definition

  The fraction of any increase in income which people plan to spend on the consumption of domestically produced goods and services
• what is MPC (marginal propensity to consume)?

  how likely people are to spend extra income
• what is MPS (marginal propensity to save)?

  how likely people are to save, import or pay taxes with extra income
• marginal propensity to save definition

  the fraction of any increase in income which people plan to save rather than spend
• multiplier formula

  1 / (1-MPC) or 1 / MPW
• what does the multiplier effect lead to?

  • more jobs being created
  • high average incomes
  • more spending
  • eventually more income is created
• the multiplier effect refers to how an initial increase in AD leads to an even bigger increase in national income
• what is the multiplier ratio?

  ratio of the rise national income to the initial rise in AD - the number of times a rise in national income is larger that the rise in the initial injection of AD, which led to the rise in national income
• How does spare capacity affect the impact of AD on economic activity?

  • with high spare capacity - higher AD mainly increases output and jobs
  • With low spare capacity - increases AD mainly increases inflation
• why is AD management important for policymakers?

  • to stabilise the economy (reduce recessions or overheating)
  • to balance growth, inflation, and unemployment
  • to coordinate with supply-side policies for long-term stability
• How odes AK link to the circular flow of income?

  • injections (I, G,X) boost AD and activity
  • Withdrawals (S, T, M) reduce AD
  • Equilibrium occurs when injections = withdrawals
• When will the multiplier be large?

  • high MPC (people spend most of extra income)
  • Low leakages (low saving, imports and taxes)
  • High confidence in the economy
• when will the multiplier be small?

  • high MPS (lots of saving, imports, or taxes)
  • low consumer confidence
  • supply-side constraints (e.g labour shortages mean spending can’t increase output much)
• how do nominal and real income affect the multiplier?

  • if nominal income rises only due to inflation, the multiplier effect is overstated (looks bigger than it really is)
  • if real income rises, the multiplier effect reflects genuine economic growth
• why does the multiplier matter for policymakers?

  • determined how effective fiscal policy (e.g government spending) will be
  • a large multiplier = spending has a strong effect on GDP
  • a small multiplier = spending leaks away, with limited impact
• what does economy activity centre on?

  the production and consumption of goods and services in the economy, together with the employment of the labour, capital and other inputs that produce output
• what do AD/AS diagrams illustrate?

  how changes in aggregate demand affect the levels of real output
• what do AD/AS not directly show?

  employment levels at each level of real output
• when real output increases, firms generally have to employ more workers to produce the additional goods and services and vice versa
• what usually leads to the multiplier effect?

  an increase or decrease in any of the components of aggregate demand such as government spending
• what does the multiplier measure?

  the relationship between a change in any of the components of aggregate demand and the resulting change in the equilibrium level of national income