Aggregate Demand & Aggregate Supply Analysis

Comprehensive flashcards covering Aggregate Demand, Short Run and Long Run Aggregate Supply, and macroeconomic equilibrium as presented in the Cambridge (CIE) A-Level Economics curriculum.

What is the definition of Aggregate Demand ($AD$)?

The total demand for all goods and services in an economy at any given average price level ($AP$).

What is the formula for calculating Aggregate Demand ($AD$) using the expenditure approach?

$AD = C + I + G + (X - M)$ where $C$ is Consumption, $I$ is Investment, $G$ is Government spending, and $(X - M)$ is Net exports (Exports - Imports).

What is included in 'Investment' ($I$) as a component of Aggregate Demand?

Total spending by firms on capital goods (machinery, equipment, and buildings), household spending on new housing, and changes in inventories (stocks) held by firms.

What creates a movement along the Aggregate Demand ($AD$) curve?

A change in the average price level ($AP$) in an economy, which leads to a contraction or expansion of real $GDP$.

How does an appreciation of the exchange rate affect Aggregate Demand ($AD$)?

It makes exports more expensive abroad and imports cheaper domestically, reducing exports ($X$) and increasing imports ($M$), which causes Net Exports to fall and the $AD$ curve to shift left.

How do falling interest rates affect Aggregate Demand ($AD$)?

They decrease the cost of borrowing and the return on saving, leading to increased consumption ($C$) and firm investment ($I$), which shifts the $AD$ curve to the right.

What is the definition of Short Run Aggregate Supply ($SRAS$)?

The total volume of goods and services that firms in an economy are willing and able to produce at a given price level over a given time period, where at least one factor of production (typically capital) is fixed.

Why is the Short Run Aggregate Supply ($SRAS$) curve upward sloping?

As firms increase output towards full capacity, unit costs of production rise because less efficient resources are used and factor prices are bid up, requiring higher prices to justify increased supply.

What causes shifts in the Short Run Aggregate Supply ($SRAS$) curve?

Changes in the conditions of supply, which generally refers to changes in the costs of production or productivity.

How does a depreciation of the exchange rate impact Short Run Aggregate Supply ($SRAS$)?

It raises the cost of imported raw materials and energy, increasing production costs and shifting the $SRAS$ curve to the left.

What real-world economic event illustrates a negative supply shock shifting $SRAS$ left due to currency depreciation?

The 2016 Brexit referendum result, which caused a sharp depreciation of sterling, leading to higher import costs and rising inflation in the UK.

What does the Long Run Aggregate Supply ($LRAS$) represent?

The potential productive capacity of an economy's factors of production, corresponding to a shift in the production possibilities frontier ($PPF$).

How does the Classical view describe the Long Run Aggregate Supply ($LRAS$) curve?

It is a vertical curve at the full employment level of output ($Y_{FE}$), representing the normal capacity level where all available resources are fully employed.

What are the three sections of the Keynesian Long Run Aggregate Supply ($LRAS$) curve?

Section 1: Highly elastic (significant spare capacity); Section 2: Upward sloping (approaching full capacity with rising unit costs); Section 3: Vertical (full employment of all resources, $Y_{FE}$).

Which factors can shift the entire Long Run Aggregate Supply ($LRAS$) curve outward?

Improvements in the quality of factors of production (e.g., technological advances, education/skills) or an increase in the quantity of factors of production (e.g., demographic changes, discovery of new resources).

In the Keynesian model, why is the price level stable in 'Section 1' of the $LRAS$ curve?

Because the economy has significant spare capacity and high unemployment, firms can bring idle resources back into production without bidding up factor prices.

Where does short-run macroeconomic equilibrium occur?

At the point where the Aggregate Demand ($AD$) curve intersects with the Short Run Aggregate Supply ($SRAS$) curve.

What is the relationship between equilibrium output and employment?

Employment moves in the same direction as real output; if output rises, firms require more workers to meet demand, and if output falls, employment falls.

What is the Keynesian justification for government intervention in the economy?

Because wages and prices are 'sticky downwards,' an economy can get stuck in a long-run equilibrium below full employment with a negative output gap; government expenditure is needed to shift $AD$ rightward.

According to the Classical view, why is government intervention to boost Aggregate Demand ($AD$) considered unnecessary?

Because the $LRAS$ is vertical at full employment ($Y_{FE}$), the economy always tends to return to that level; boosting $AD$ would simply be inflationary without increasing long-term output.