Aggregate Demand and Aggregate Supply

Question 1

• Aggregate demand

Answer 1

the total amount of spending in the economy from all of the different sectors

Question 2

o Three effects of AD and why it is negative

Answer 2

o Income effect
 As price level changes, real value of households income or wealth is affected
• E.g. if price level rises (inflation rate rises), purchasing power of your income or wealth falls

o Interest rate effect
 A rise in the general price level means that households and firms need to demand more funds to finance their transactions
 The rising demand for money drives interest rates upwards, increasing the cost of borrowing and acting as a disincentive to spending
 Summary
• Rise in price level increases interest rates which reduces investment and consumption

o Open economy effect
 If domestic price level (inflation) rises relative to other countries, domestic goods and services will become less competitive in those countries
• This means that there will be fall in exports
 At the same time, rise in domestic price level will mean consumers and firms will purchase more goods and services from foreign producers and less from domestic producers
• Spending on import will increase and net exports will fall

Question 3

Shifts in AD curve

Answer 3

• Can shift left or right if any non-price level factor affecting spending were to change
• Shift right in AD means AD increases and thus real GDP increases
• Shift left in AD means AD decreases and thus real GDP decreases

Question 4

Aggregate Supply

Answer 4

• The total amount for all goods and services domestic producers are willing and able to make available for sale at each price level
• Keynesian Range
• > Where output can be increased significantly w/ little impact on price/ inflation (price levels)
• > Has Excess capacity
• > Indicators: high UE, Low Inflation, Low Growth
• Intermediate Range
• > Where output increases at same rate / proportion of price and inflation
• Classical Range
• > Where output increases will lead to large impacts on inflation
• > Curve reaches vertical = maximum capacity, output can not increase
• > No excess capacity
• > Indicators: Low UE, Shortage in employment, High inflation, High growth