Flashcards · H060 · Topic 5

Aggregate demand and aggregate supply flashcards

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Injections vs leakages (withdrawals): Injections: investment, government spending, exports. Leakages: saving, taxation, imports. Equilibrium in the flow: withdrawals equal injections.
Physical vs monetary flows: Physical: goods, services and factor services. Monetary: payments for them, moving in the opposite direction.
The three methods of measuring national income: Output: sum of value added. Income: sum of factor incomes (wages, rent, interest, profit). Expenditure: C + I + G + (X − M).
National income multiplier: The eventual change in income divided by the injection that started it. k = 1 ÷ MPW, where MPW = MPS + MRT + MPM.
MPW is 0.5. An injection of 30bn. Final change in national income?: k = 1 ÷ 0.5 = 2. Income rises by 2 × 30 = 60bn (the rise in real GDP is smaller if prices rise).

Aggregate demand and its components: Planned spending on home-produced output at each price level. AD = C + I + G + (X − M).
APC vs MPC: APC = C ÷ Yd. MPC = ΔC ÷ ΔYd. APC + APS = 1 and MPC + MPS = 1.
Influences on consumption and investment: Consumption: income, interest rates, wealth, confidence, credit. Investment: expected demand (the accelerator), interest rates, confidence, technology, government policy.
Accelerator: Net investment depends on the change in output (income), not its level: net investment = v × ΔY.
Movement along AD vs shift of AD: A change in the price level moves the economy along AD. A change in planned spending on any component at every price level shifts it.

Aggregate supply: Planned real output of all producers at each price level.
SRAS vs LRAS (OCR definitions): SRAS: when some costs, especially nominal wages, are fixed; slopes upwards. LRAS: productive capacity once costs and prices have adjusted; depends on factors and technology.
What shifts SRAS?: Changes in costs of production: wages, raw material and energy prices, import prices, indirect taxes. A cost rise shifts SRAS left.
What shifts LRAS?: Changes in the quantity or quality of factors: technology, education and skills, investment, labour force size, and institutions.
Keynesian vs classical LRAS: Keynesian: horizontal with a lot of spare capacity, then rising, then vertical at full capacity. Classical: vertical at the full-capacity output.

Diagram: AD rises in an economy with spare capacity: Price level on the vertical axis, real output on the horizontal. AD shifts right; real output rises a lot and the price level only a little.
Diagram: AD rises near full capacity: AD shifts right where AS is steep or vertical: mostly a higher price level (demand-pull inflation), with little extra real output.
Diagram: a cost-push shock: SRAS shifts left. The price level rises and real output falls: stagflation (falling output with rising prices).
Diagram: an increase in productive capacity: LRAS shifts right. Real output can rise without a higher price level, or with a lower one.

Macroeconomic equilibrium: The price level and real output where AD equals SRAS.
Long-run equilibrium: AD, SRAS and LRAS all meet at one point: output is at potential.
Potential output: Output at the economy's capacity, shown by the LRAS curve. A negative output gap means actual output is below it.
Why is the rise in real GDP smaller than the shift of AD?: The AD shift equals injection × multiplier at a given price level, but as AD rises along an upward-sloping SRAS, part of the extra demand raises prices instead of output.