2.4: National income

• What occurs at the point of real national output equilibrium?(SRAS)

  Aggregate demand intersects with aggregate supply
• What happens when there are changes to the components of aggregate demand (AD)?

  The AD curve shifts left or right, creating a new short-run equilibrium
• What is the effect of changes to the determinants of short-run aggregate supply (SRAS)?

  It shifts the SRAS curve left or right, creating a new short-run equilibrium
• How do Classical and Keynesian economists differ in their views on long-run equilibrium of real national output?

  • Classical economists:
  • Believe the economy returns to full potential output
  • Only the average price level changes in the long-run
  • Keynesian economists:
  • Believe the economy can be in long-run equilibrium at any output level
• What do Classical economists believe about the economy's return to output levels?

  They believe the economy will always return to its full potential level of output
• According to Keynesian economists, at what levels can the economy be in long-run equilibrium?


  At any level of output
• What does the LRAS curve demonstrate?


  The maximum possible output of an economy using all of its scarce resources
• Where does the SRAS intersect with AD?


  At the LRAS curve
• What does it mean when an economy is producing at the full employment level of output?


  It means all resources are being utilized efficiently
• How does the Keynesian view describe the LRAS curve at certain price levels?


  The LRAS curve becomes elastic as prices cannot fall further
• What factors can cause the LRAS curve to become elastic according to the Keynesian view?


  Minimum wage laws, trade unions, or long-term employment contracts
• What does real output national equilibrium signify in the Keynesian view?


  It can occur at any level of output
• What does the equilibrium represent in the classical view of an increase in SRAS?


  A recessionary or negative output gap
• What happens when one of the determinants of SRAS increases?


  The SRAS curve shifts to the right
• What occurs to average prices and real output when SRAS increases?


  Average prices fall and real output increases
• What does the new short-run equilibrium indicate after an increase in SRAS?


  It still has a negative output gap but smaller
• How do changes to the determinants of LRAS affect the classical model?


  They change the long-run productive potential of the economy
• How do changes to the determinants of LRAS affect the Keynesian model?


  They do not change long-run productive potential of the economy
• What is the multiplier ratio?


  The ratio of change in real income to the injection that created the change
• What is the basis of the multiplier process?


  One individual's spending is another individual's income
• Why is the final increase in national income larger than the initial injection?


  Due to successive rounds of spending
• What determines the size of the multiplier?


  The size of leakages that occur during the process
• What happens to AD when there is an initial injection?


  It shifts to the right
• How do withdrawals affect the value of the multiplier?


  The greater the withdrawals, the smaller the value of the multiplier
• How does the marginal propensity to consume (MPC) affect the multiplier?


  The greater the MPC, the greater the value of the multiplier
• What happens to the multiplier if taxes increase?


  The value of the multiplier reduces
• How do interest rates affect the multiplier?


  If interest rates increase, savings increase and consumption decreases, reducing the multiplier
• What happens to the multiplier when exchange rates appreciate?


  The level of imports will increase and the multiplier decreases
• How does increased confidence in the economy affect consumption and the multiplier?


  Consumption increases and the multiplier increases
• Why is it useful for the government to know the value of the multiplier?


  To judge the likely economic growth caused by increased spending
• What is a time lag in the context of the multiplier?


  It takes time for the successive rounds of income to work through the economy
• What do the 'marginal propensities' refer to?


  The proportion of the next dollar earned that a consumer saves, consumes, is taxed, or purchases imports with
• How are marginal propensities calculated?


  They are calculated for economies to provide insights into income allocation
• What are the key differences between the Classical and Keynesian views of LRAS?


  Classical view:

  • LRAS demonstrates maximum output
  • Changes to LRAS affect long-run productive potential

  
  

  Keynesian view:

  • LRAS becomes elastic at certain price levels
  • Changes to LRAS do not affect long-run productive potential
• What are the determinants of SRAS and how do they affect the economy?


  Determinants of SRAS:

  • Input prices
  • Productivity
  • Government policies

  
  

  Effects:

  • Increase in SRAS leads to lower prices and higher output
  • Decrease in SRAS leads to higher prices and lower output
• What is the significance of the multiplier in economics?


  • Measures the impact of an initial injection on national income
  • Indicates how spending circulates through the economy
  • Helps government predict economic growth from spending
• Marginal Propensity to Consume


  Proportion of income that is spent.
• Marginal Propensity to Save


  Proportion of additional income that is saved
• Marginal Propensity to Tax


  Proportion of additional income that is paid in tax
• Marginal Propensity to Import


  Proportion of income that is spend on imports