What is aggregate demand?
Total spending on domestically produced goods and services in an economy over a period of time
Aggregate demand is calculated as AD = consumer spending (C) + investment expenditure (I) + government spending (G) + net exports (X-M).
What does the real balance effect describe?
- Prices decrease: people feel richer, spending increases
- Prices increase: people feel poorer, spending decreases
This effect illustrates how changes in price levels can influence consumer behavior.
What is the net export effect?
- Higher domestic price levels: decrease net exports, lower aggregate demand
- Lower domestic price levels: increase net exports, increasing aggregate demand
This effect highlights the relationship between domestic prices and international trade.
What happens to interest rates when prices increase?
Interest rates rise due to increased borrowing
Higher prices lead to increased demand for loans, which can decrease consumption and aggregate demand.
What causes a movement along the AD curve?
Change in overall price level
Movements along the curve reflect changes in the quantity of aggregate demand at different price levels.
What causes shifts along the AD curve?
Change in components of consumption, investment, government expenditure, or net exports
Shifts indicate a change in aggregate demand due to factors other than price.
Define marginal propensity to consume.
Proportion of additional income spent on consumption rather than saving
This concept helps understand consumer behavior in response to income changes.
Define marginal propensity to save.
Proportion of additional income saved rather than spent on consumption
This concept complements the marginal propensity to consume.
What is the multiplier effect?
Units increase in AD leads to higher income, increasing consumption further
The multiplier effect illustrates how initial spending can lead to greater overall economic impact.
What is aggregate supply?
Total planned output of goods and services firms are willing and able to supply at a given price
Aggregate supply reflects the production capacity of an economy.
Define short run in economic terms.
Period where at least one factor of production is fixed
Typically, capital is the fixed factor during the short run.
What is short run aggregate supply (SRAS)?
Total quantity of goods and services produced at various levels in the short run
SRAS is influenced by fixed factors like technology or capital.
What causes an expansion of SRAS?
Increase in aggregate price level leads to increased output
This is due to sticky wages and prices in the short run.
What causes a contraction of SRAS?
Fall in price levels
A decrease in prices can lead to reduced output in the short run.
List factors affecting SRAS.
- Unit wage costs
- Labour productivity
- Raw material and energy prices
- Business taxes and subsidies
- Exchange rate changes
- Supply shocks
These factors can influence the total output firms are willing to supply.
What is a negative output gap?
Actual output is below potential output
This indicates underutilization of resources in the economy.
What is a positive output gap?
Actual output is above potential output
This can lead to rising demand-pull and cost-push inflation.
Define actual economic growth.
Real, measured increase in a country’s GDP
This contrasts with potential economic growth, which is the maximum sustainable output.
List characteristics of a boom.
- Economic growth
- Decreased unemployment
- Inflationary pressures
- Increased consumer and business confidence
A boom indicates a thriving economy.
List characteristics of a recession.
- Decreased economic growth
- Increased unemployment
- Lower consumer and business confidence
- Increased government budget balance
A recession indicates economic contraction.
What is a depression?
Persistent and severe downturn in output and jobs
An economy operates well below its productive potential during a depression.
