determinants

Determinants of DEMAND (shifters of the demand curve) — overview

Six factors shift the demand curve LEFT or RIGHT (change in demand — NOT a movement along). A rightward shift = increase in demand (more demanded at every price). A leftward shift = decrease in demand. The good's OWN PRICE is NOT a determinant — it causes movement ALONG the curve. Mnemonic: ITPEN (Income, Tastes, Prices of related goods, Expectations, Number of consumers, Advertising/information).

Income — determinant of DEMAND (normal good)

WHAT IT DETERMINES: position of the demand curve. HOW: for normal goods (YED > 0) — income RISES → demand INCREASES → D shifts RIGHT. Income FALLS → demand DECREASES → D shifts LEFT. EXAMPLE: Rising Austrian household incomes → demand for foreign holidays shifts right. DIAGRAM: D1 shifts to D2 (right). At every price, more is demanded after income rise.

Income — determinant of DEMAND (inferior good)

WHAT IT DETERMINES: position of the demand curve. HOW: for inferior goods (YED < 0) — income RISES → demand DECREASES → D shifts LEFT. Income FALLS → demand INCREASES → D shifts RIGHT. EXAMPLE: As incomes rise, demand for bus travel falls (people buy cars). DIAGRAM: D1 shifts to D2 (left) when income rises.

Prices of substitute goods — determinant of DEMAND

WHAT IT DETERMINES: position of the demand curve for a good. HOW: if price of a SUBSTITUTE rises → consumers switch to this good → demand INCREASES → D shifts RIGHT. If price of substitute falls → demand for this good DECREASES → D shifts LEFT. EXAMPLE: Price of Pepsi rises → demand for Coca-Cola shifts right. DIAGRAM: Rise in price of Good B → D curve for substitute Good A shifts right.

Prices of complement goods — determinant of DEMAND

WHAT IT DETERMINES: position of the demand curve for a good. HOW: if price of a COMPLEMENT rises → consumers buy less of the complement AND less of this good → demand DECREASES → D shifts LEFT. EXAMPLE: Price of petrol rises → demand for cars shifts left (both goods consumed together). DIAGRAM: Rise in price of Good B → D curve for complement Good A shifts left.

Tastes and preferences — determinant of DEMAND

WHAT IT DETERMINES: position of the demand curve. HOW: if good becomes MORE fashionable/desirable → demand INCREASES → D shifts RIGHT. If tastes shift away → demand DECREASES → D shifts LEFT. Influenced by: advertising, social trends, health information, cultural changes. EXAMPLE: Growing health consciousness → demand for organic food shifts right. Declining readership → demand for print newspapers shifts left.

Expectations of future prices — determinant of DEMAND

WHAT IT DETERMINES: position of the CURRENT demand curve. HOW: if consumers expect prices to RISE in future → buy more NOW → current demand INCREASES → D shifts RIGHT. If consumers expect prices to FALL → delay purchases → current demand DECREASES → D shifts LEFT. EXAMPLE: Expected petrol price rise → consumers fill tanks now → current demand shifts right.

Number of consumers in the market — determinant of DEMAND

WHAT IT DETERMINES: position of the market demand curve. HOW: MORE consumers in market → market demand INCREASES → D shifts RIGHT. FEWER consumers → market demand DECREASES → D shifts LEFT. EXAMPLE: Population growth → demand for housing shifts right. Market opened to new countries → export demand shifts right.

Advertising and information — determinant of DEMAND

WHAT IT DETERMINES: position of the demand curve. HOW: successful advertising increases consumer awareness and changes tastes → demand INCREASES → D shifts RIGHT. Negative information (health warnings, bad publicity) → demand DECREASES → D shifts LEFT. EXAMPLE: Nike advertising campaign → demand for Nike trainers shifts right. Government anti-smoking campaigns → demand for cigarettes shifts left.

Determinants of SUPPLY (shifters of the supply curve) — overview

Seven factors shift the supply curve LEFT or RIGHT (change in supply). A rightward shift = increase in supply (more supplied at every price). A leftward shift = decrease in supply. The good's OWN PRICE is NOT a determinant — it causes movement ALONG the curve. Mnemonic: CONTEST (Costs, Other prices in production, Number of firms, Technology, Expectations, Subsidies/taxes, natural conditions).

Costs of production — determinant of SUPPLY

WHAT IT DETERMINES: position of the supply curve. HOW: if production costs RISE (wages, raw materials, energy prices) → supply DECREASES → S shifts LEFT (less supplied at every price, or need higher price to supply same amount). If costs FALL → supply INCREASES → S shifts RIGHT. EXAMPLE: Rise in global oil prices increases transport costs → supply of most goods shifts left. Technological cost reduction → supply shifts right.

Technology — determinant of SUPPLY

WHAT IT DETERMINES: position of the supply curve. HOW: improvements in technology REDUCE production costs and increase efficiency → supply INCREASES → S shifts RIGHT (more supplied at every price). EXAMPLE: Automation in car manufacturing → supply of cars shifts right. Agricultural mechanisation → supply of wheat shifts right. Key driver of long-run supply growth.

Prices of related goods in production — substitutes in production — determinant of SUPPLY

WHAT IT DETERMINES: position of supply curve for a good. HOW: if price of a SUBSTITUTE IN PRODUCTION rises → producers switch resources toward that good → supply of the original good DECREASES → S shifts LEFT. EXAMPLE: Wheat prices rise → farmers switch land from barley to wheat → supply of barley shifts left.

Prices of related goods in production — complements in production (joint supply) — determinant of SUPPLY

WHAT IT DETERMINES: position of supply curve for a jointly supplied good. HOW: if production of one good INCREASES → supply of the jointly produced good AUTOMATICALLY INCREASES → S shifts RIGHT. EXAMPLE: More cattle slaughtered for beef → more leather available → supply of leather shifts right. Petrol and diesel jointly produced from crude oil.

Number of firms in the market — determinant of SUPPLY

WHAT IT DETERMINES: position of the market supply curve. HOW: MORE firms entering the market → market supply INCREASES → S shifts RIGHT. Firms EXITING → market supply DECREASES → S shifts LEFT. EXAMPLE: New coffee shops opening → supply of coffee in city shifts right. Firms going bankrupt in a recession → supply shifts left.

Expectations of future prices — determinant of SUPPLY

WHAT IT DETERMINES: position of the CURRENT supply curve. HOW: if producers expect prices to RISE in future → withhold current supply (build stocks) → current supply DECREASES → S shifts LEFT. If expect prices to FALL → sell now → current supply INCREASES → S shifts RIGHT. EXAMPLE: Oil producers expect higher prices next quarter → reduce current output → S shifts left now.

Indirect taxes — determinant of SUPPLY

WHAT IT DETERMINES: position of the supply curve. HOW: a specific (per unit) indirect tax INCREASES production costs → supply DECREASES → S shifts LEFT (upward) by the amount of the tax per unit. Parallel leftward shift. EXAMPLE: €3 per unit excise tax on cigarettes → supply curve shifts left by €3 at every quantity. At every price, firms supply less (must receive higher price to cover the tax).

Subsidies — determinant of SUPPLY

WHAT IT DETERMINES: position of the supply curve. HOW: a subsidy REDUCES production costs → supply INCREASES → S shifts RIGHT (downward) by the amount of the subsidy per unit. Parallel rightward shift. EXAMPLE: Government subsidises solar panel manufacturers → supply of solar panels shifts right. At every price, firms supply more (costs are reduced by subsidy amount).

Natural conditions and weather — determinant of SUPPLY

WHAT IT DETERMINES: position of the supply curve (particularly agricultural). HOW: FAVOURABLE weather → supply INCREASES → S shifts RIGHT. Drought, floods, disease, natural disasters → supply DECREASES → S shifts LEFT. EXAMPLE: Bumper harvest → supply of wheat shifts right → price falls. East African drought → supply of coffee shifts left → price rises.

Determinants of PED — overview

PED measures responsiveness of Qd to price change. Determinants affect HOW ELASTIC OR INELASTIC demand is — they determine the VALUE of PED (whether |PED| > 1 or < 1), not the position of the demand curve. Mnemonic: SPLAT (Substitutes, Proportion of income, Luxury vs necessity, Addictiveness, Time period).

Number and closeness of substitutes — determinant of PED

WHAT IT DETERMINES: the value of |PED| (how elastic demand is). HOW: MORE and CLOSER substitutes → MORE ELASTIC demand (higher |PED|). If price rises, consumers easily switch → Qd falls a lot. FEWER or NO close substitutes → MORE INELASTIC demand (lower |PED|). EXAMPLE: A specific brand of cola has many substitutes → elastic demand. Petrol in the short run has few substitutes → inelastic demand. This is the MOST IMPORTANT determinant of PED.

Necessity vs luxury — determinant of PED

WHAT IT DETERMINES: the value of |PED|. HOW: NECESSITIES (food, medicine, electricity) → more INELASTIC demand (lower |PED|) — consumers must buy regardless of price. LUXURIES (designer handbags, foreign holidays) → more ELASTIC demand (higher |PED|) — consumers can easily forgo if price rises. EXAMPLE: Insulin for diabetics → |PED| ≈ 0 (perfectly inelastic). Foreign holidays → |PED| = 1.5–2.5 (elastic).

Proportion of income spent on the good — determinant of PED

WHAT IT DETERMINES: the value of |PED|. HOW: HIGHER proportion of income spent → MORE ELASTIC demand. Consumers pay more attention to price changes for expensive items. LOWER proportion → MORE INELASTIC. EXAMPLE: A new car (large proportion of income) → consumers very responsive to price change → elastic. A box of matches (tiny proportion) → price change ignored → inelastic.

Time period — determinant of PED

WHAT IT DETERMINES: the value of |PED|. HOW: LONGER time period → MORE ELASTIC demand. In the short run consumers are locked into habits and contracts. Over time they find alternatives and adjust behaviour → Qd responds more. SHORTER time period → MORE INELASTIC. EXAMPLE: Petrol price rise → short run inelastic (still need to commute). Long run: buy more fuel-efficient car, move closer to work → demand becomes more elastic.

Addictiveness and habit formation — determinant of PED

WHAT IT DETERMINES: the value of |PED|. HOW: HABIT-FORMING or ADDICTIVE goods → MORE INELASTIC demand. Consumers find it difficult to reduce consumption even when price rises. EXAMPLE: Cigarettes, alcohol, coffee → consumers continue purchasing despite price rises → |PED| is low. This is why governments raise excise taxes on these goods — inelastic demand guarantees significant revenue with relatively little fall in quantity.

Breadth of market definition — determinant of PED

WHAT IT DETERMINES: the value of |PED|. HOW: NARROWLY defined market → MORE ELASTIC (many more substitutes for a specific brand than for the category). BROADLY defined → MORE INELASTIC. EXAMPLE: "Nespresso Original pods" (narrow) → many substitutes (other pods, other coffee) → elastic. "Hot drinks" (broad) → few substitutes → inelastic. "Food" (very broad) → almost perfectly inelastic. The narrower the market definition, the higher the |PED|.

Determinants of YED — overview

YED measures responsiveness of Qd to changes in INCOME. Determinants affect: (1) The SIGN of YED (positive = normal good; negative = inferior good). (2) The MAGNITUDE of YED (how income elastic or inelastic). Key factor: whether the good is a luxury, necessity, or inferior good in consumers' perceptions.

Nature of the good (luxury vs necessity vs inferior) — determinant of YED

WHAT IT DETERMINES: the sign and magnitude of YED. HOW: LUXURY goods → YED > +1 (income elastic — demand rises proportionally MORE than income). NECESSITY goods → 0 < YED < +1 (income inelastic — demand rises less than income). INFERIOR goods → YED < 0 (demand FALLS as income rises). EXAMPLE: Foreign holidays → YED ≈ +2–3 (luxury). Bread → YED ≈ +0.1–0.3 (necessity). Bus travel → YED ≈ −0.4 (inferior). Determined by consumer preferences and the availability of higher-quality substitutes as income rises.

Level of income (absolute and relative) — determinant of YED

WHAT IT DETERMINES: magnitude and sometimes sign of YED. HOW: a good may be a LUXURY at LOW income levels (YED > 1) but become a NECESSITY at HIGHER income levels (YED falls toward 0–0.5) as it becomes standard. Also: a good that is INFERIOR for high-income households may be NORMAL for low-income households. EXAMPLE: A car is a luxury for very low-income households (high YED); becomes a necessity for middle-income households (YED falls); may become inferior for ultra-wealthy (who buy multiple premium cars — different good). YED is not a fixed property of a good — it depends on the income level of the consumer.

Consumer preferences and cultural factors — determinant of YED

WHAT IT DETERMINES: the sign and magnitude of YED. HOW: consumer tastes determine which goods are perceived as luxuries, necessities, or inferior — and this varies across cultures and societies. EXAMPLE: In some cultures, eating at restaurants is a luxury (high positive YED). In others it is a social necessity (low positive YED). Whether a good is classified as inferior also depends on cultural attitudes toward the good.

Availability of higher-quality substitutes — determinant of YED

WHAT IT DETERMINES: whether a good has negative YED (inferior) or positive YED (normal). HOW: as income rises, consumers switch FROM inferior goods TO higher-quality alternatives. If a GOOD-QUALITY ALTERNATIVE EXISTS → income rise → demand for the inferior good falls → YED is negative. If NO good alternative → even as income rises, demand continues rising → YED remains positive. EXAMPLE: Bus travel is inferior because cars are the higher-quality alternative. If no cars existed, bus travel would be a normal good.

Determinants of PES — overview

PES measures responsiveness of Qs to changes in PRICE. Determinants affect how elastic or inelastic supply is — the VALUE of PES. They determine how quickly and easily producers can increase output when price rises. Mnemonic: TIME-SF (Time period, Inventories/stocks, Mobility of factors, Existence of spare capacity, Spare production capacity, Factor specificity).

Time period — determinant of PES

WHAT IT DETERMINES: the value of PES (how elastic or inelastic supply is). HOW: LONGER time period → MORE ELASTIC supply (PES rises over time). IMMEDIATE RUN: PES = 0 (output completely fixed — perfectly inelastic). SHORT RUN: some inputs can be varied → PES > 0 but still relatively inelastic. LONG RUN: all inputs variable, new firms enter → PES is most elastic. EXAMPLE: House prices rise → immediate run: no new houses (PES = 0). After years of construction: supply responds (PES rises). This is the MOST IMPORTANT determinant of PES.

Availability of stocks and inventories — determinant of PES

WHAT IT DETERMINES: the value of PES. HOW: if firms hold LARGE STOCKS of finished goods → can increase supply immediately by releasing stocks → MORE ELASTIC supply (higher PES). If stocks are LOW or the good is PERISHABLE (cannot be stored) → cannot release stocks → LESS ELASTIC supply. EXAMPLE: A supermarket with large warehouses can quickly increase supply of tinned goods (elastic). A fresh fish supplier cannot store supply → very inelastic. A book publisher with warehouse stock can respond quickly to demand; a concert cannot add seats.

Spare production capacity — determinant of PES

WHAT IT DETERMINES: the value of PES. HOW: firms with SPARE/IDLE CAPACITY (underemployed machinery, empty factory space, available workers) → can increase output quickly when price rises → MORE ELASTIC supply. Firms at FULL CAPACITY → cannot expand without costly new investment → LESS ELASTIC. EXAMPLE: A factory running at 60% capacity → highly elastic supply response to price rise. A factory at 100% → perfectly inelastic in short run without major investment.

Mobility of factors of production — determinant of PES

WHAT IT DETERMINES: the value of PES. HOW: if factors of production can be EASILY MOVED into this industry from other uses → MORE ELASTIC supply (resources can be rapidly redeployed). If factors are SPECIALISED or IMMOBILE → LESS ELASTIC supply. EXAMPLE: General labour can switch between industries relatively easily → more elastic. A highly specialised oil rig worker cannot easily produce something else → less elastic supply of oil extraction.

Length and complexity of production process — determinant of PES

WHAT IT DETERMINES: the value of PES. HOW: LONGER and MORE COMPLEX production process → LESS ELASTIC supply (firms cannot respond quickly to price signals). SHORTER production cycle → MORE ELASTIC supply. EXAMPLE: Building a nuclear power plant takes 10–15 years → PES ≈ 0 in medium run. Growing wine grapes takes years → inelastic. Mass-producing a smartphone case takes days → elastic. Wheat takes a growing season → inelastic within the season.

Nature of the industry (primary vs secondary vs tertiary) — determinant of PES

WHAT IT DETERMINES: the value of PES. HOW: PRIMARY industries (agriculture, mining) → generally INELASTIC supply (constrained by natural cycles, weather, geological conditions). SECONDARY industries (manufacturing) → MORE ELASTIC supply (can scale production using existing technology). SERVICE industries vary widely → some very elastic (add staff), others very inelastic (surgeon cannot be quickly trained). EXAMPLE: Agricultural wheat (inelastic PES ≈ 0.1–0.3). Mass-produced electronics (elastic PES > 1).

Determinants of AGGREGATE DEMAND (AD) — overview

AD = C + I + G + (X − M). AD shifts when any component changes for reasons OTHER than the price level. A rightward shift of the AD curve = increase in AD. A leftward shift = decrease in AD. The PRICE LEVEL causes movement ALONG the AD curve (not a shift). Determinants are factors affecting C, I, G, or (X−M).

Consumer confidence — determinant of AD (via C)

WHAT IT DETERMINES: position of the AD curve (via consumption C). HOW: HIGHER consumer confidence → households more willing to spend → C rises → AD shifts RIGHT. LOWER confidence → precautionary saving rises → C falls → AD shifts LEFT. EXAMPLE: COVID-19 → consumer confidence collapsed → C fell dramatically → AD shifted sharply left. Post-pandemic recovery → confidence returned → C surged → AD shifted right.

Interest rates — determinant of AD (via C and I)

WHAT IT DETERMINES: position of AD curve (via both consumption C and investment I). HOW: LOWER interest rates → borrowing cheaper → C rises (mortgages, consumer credit) AND I rises (business loans cheaper) → AD shifts RIGHT. HIGHER rates → borrowing more expensive → C and I fall → AD shifts LEFT. EXAMPLE: ECB rate cuts 2014–2022 (near zero) → investment and consumption supported → AD rightward. ECB rate rises 2022–23 → C and I fell → AD leftward.

Wealth levels — determinant of AD (via C)

WHAT IT DETERMINES: position of AD curve via consumption. HOW: RISING asset prices (housing, shares) → households feel wealthier → increase consumption even without income rise (wealth effect) → AD shifts RIGHT. FALLING asset prices → wealth effect reverses → C falls → AD shifts LEFT. EXAMPLE: UK house price boom (2000s) → rising housing wealth → homeowners borrowed against equity → C rose → AD shifted right. 2008 house price crash → wealth effect reversed → C collapsed.

Household income and disposable income — determinant of AD (via C)

WHAT IT DETERMINES: position of AD curve via consumption. HOW: HIGHER disposable income (from tax cuts or wage rises) → more household spending → C rises → AD shifts RIGHT. LOWER disposable income → C falls → AD shifts LEFT. EXAMPLE: Income tax cut → disposable income rises → C rises → AD shifts right. VAT rise → real disposable income falls → C falls → AD shifts left.

Business confidence (animal spirits) — determinant of AD (via I)

WHAT IT DETERMINES: position of AD curve via investment. HOW: HIGH business confidence (optimistic about future demand and profits) → firms increase investment spending → I rises → AD shifts RIGHT. LOW confidence → investment collapses → I falls → AD shifts LEFT. This is why investment is the most volatile component of AD — confidence can change rapidly and dramatically. EXAMPLE: 2008 financial crisis → business confidence collapsed → global investment fell sharply → AD shifted dramatically left.

Corporate taxes — determinant of AD (via I)

WHAT IT DETERMINES: position of AD curve via investment. HOW: LOWER corporation tax → higher post-tax profits → more retained earnings available for investment AND more incentive to invest → I rises → AD shifts RIGHT. HIGHER corporation tax → I falls → AD shifts LEFT. EXAMPLE: Ireland's 12.5% corporation tax attracted massive FDI and investment → significantly boosted Irish AD.

Government spending (G) — determinant of AD

WHAT IT DETERMINES: position of AD curve directly (G is a component of AD). HOW: INCREASE in G → AD shifts RIGHT directly, amplified by the multiplier. DECREASE in G → AD shifts LEFT. EXAMPLE: EU COVID Recovery Fund → massive increase in G across Eurozone → AD shifted right → supported recovery. UK austerity 2010–15 → G cut → AD shifted left → recovery slowed.

Taxation — determinant of AD (via C and I)

WHAT IT DETERMINES: position of AD curve via disposable income and investment. HOW: TAX CUT → disposable income rises → C rises → AD shifts RIGHT (amplified by tax multiplier). TAX RISE → disposable income falls → C falls → AD shifts LEFT. Also: corporation tax affects I. Indirect tax affects SRAS (costs) not directly AD. EXAMPLE: US CARES Act (2020) → $1,200 direct payments → disposable income rose → C surged → AD shifted right.

Exchange rate — determinant of AD (via X−M)

WHAT IT DETERMINES: position of AD curve via net exports (X−M). HOW: DEPRECIATION of domestic currency → exports cheaper for foreigners (X rises) AND imports more expensive for domestic consumers (M falls) → (X−M) rises → AD shifts RIGHT. APPRECIATION → exports more expensive, imports cheaper → (X−M) falls → AD shifts LEFT. EXAMPLE: Sterling depreciated 15% post-Brexit vote (2016) → UK exports became more competitive → X rose → AD partially supported.

Foreign income levels — determinant of AD (via X)

WHAT IT DETERMINES: position of AD curve via exports. HOW: HIGHER income in trading partner countries → more foreign spending on domestic exports → X rises → AD shifts RIGHT. LOWER foreign income (trading partner recession) → export demand falls → X falls → AD shifts LEFT. EXAMPLE: China's rapid growth (2000s) → huge increase in demand for German machinery, Australian commodities → exports surged → AD in Germany and Australia shifted right.

Relative inflation rates — determinant of AD (via X−M)

WHAT IT DETERMINES: position of AD curve via net exports. HOW: if DOMESTIC INFLATION is LOWER than trading partners → domestic goods become relatively cheaper → exports rise, imports fall → (X−M) rises → AD shifts RIGHT. If domestic inflation HIGHER → exports less competitive → (X−M) falls → AD shifts LEFT. EXAMPLE: Germany's low inflation within the eurozone (relative to Greece, Spain, Italy) → German exports remained competitive → persistent current account surplus → AD supported.

Credit availability — determinant of AD (via C and I)

WHAT IT DETERMINES: position of AD curve via consumption and investment. HOW: EASIER credit conditions (banks willing to lend, lower lending standards) → households and firms borrow more → C and I rise → AD shifts RIGHT. TIGHTER credit (credit crunch — banks refuse to lend) → C and I collapse → AD shifts LEFT. EXAMPLE: 2008 financial crisis → banks stopped lending → credit crunch → C and I collapsed → AD shifted dramatically left even before interest rates rose.

Determinants of LONG-RUN AGGREGATE SUPPLY (LRAS) — overview

LRAS is vertical at potential output (Yf) in the Classical model. It shifts when the economy's PRODUCTIVE CAPACITY changes. A rightward shift = economic growth (more can be produced at any price level). Causes: changes in quantity or quality of factors of production, technological progress, and institutional improvements. These are all SUPPLY-SIDE factors.

Quantity of labour — determinant of LRAS

WHAT IT DETERMINES: position of the LRAS curve (potential output Yf). HOW: MORE workers → economy can produce more → LRAS shifts RIGHT. FEWER workers → LRAS shifts LEFT. Affected by: population growth, immigration, increased labour force participation (more women working, later retirement), reduced emigration. EXAMPLE: Post-WW2 baby boom → growing labour force → LRAS shifted right through 1970s–80s. COVID-19 → reduced labour supply (deaths, long COVID) → effective LRAS shifted left.

Quality of labour (human capital) — determinant of LRAS

WHAT IT DETERMINES: position of LRAS (and SRAS). HOW: BETTER educated, trained, and healthier workers are more productive → same number of workers produce more output → LRAS shifts RIGHT. DETERIORATION of human capital (brain drain, poor education, disease burden) → LRAS shifts LEFT. EXAMPLE: Germany's dual apprenticeship system → highly skilled workforce → LRAS shifts right over time. HIV/AIDS epidemic in sub-Saharan Africa → reduced workforce quality and size → effective LRAS shifted left.

Quantity of physical capital — determinant of LRAS

WHAT IT DETERMINES: position of LRAS. HOW: MORE machinery, equipment, and infrastructure → economy can produce more → LRAS shifts RIGHT. Net capital accumulation (gross investment > depreciation) → LRAS shifts right over time. Capital destruction (war, natural disasters) → LRAS shifts LEFT. EXAMPLE: China's massive investment (40% of GDP) → rapid capital accumulation → LRAS shifted dramatically right over 30 years.

Quality of physical capital and technology — determinant of LRAS

WHAT IT DETERMINES: position of LRAS. HOW: TECHNOLOGICAL PROGRESS reduces cost per unit of output and increases total factor productivity (TFP) → more output from same inputs → LRAS shifts RIGHT. This is the MOST IMPORTANT long-run driver of economic growth (Solow residual). EXAMPLE: The IT revolution (1990s–2000s) → raised TFP across all sectors → LRAS shifted right. Automation in manufacturing → same capital produces more output → LRAS shifts right.

Infrastructure quality — determinant of LRAS

WHAT IT DETERMINES: position of LRAS. HOW: BETTER transport, energy, and digital infrastructure → reduces production and transaction costs for all firms → TFP rises → LRAS shifts RIGHT. POOR infrastructure → high transport costs, unreliable energy → reduces productive capacity → LRAS effectively shifts LEFT. EXAMPLE: Sub-Saharan Africa's infrastructure deficit costs ~2% of growth per year. China's high-speed rail network → market integration → productivity rise → LRAS shifted right.

Institutional quality — determinant of LRAS

WHAT IT DETERMINES: position of LRAS. HOW: BETTER institutions (property rights, rule of law, absence of corruption, political stability, contract enforcement) → investment incentivised → resources allocated efficiently → LRAS shifts RIGHT. WEAK institutions → investment deterred, resources misallocated → LRAS effectively lower. EXAMPLE: Botswana's strong institutions → diamonds invested productively → LRAS shifted right. Zimbabwe's institutional collapse (2000) → LRAS shifted dramatically left.

Natural resources — determinant of LRAS

WHAT IT DETERMINES: position of LRAS. HOW: DISCOVERY of new natural resources (oil, minerals) → productive capacity increases → LRAS shifts RIGHT. DEPLETION of natural resources → productive capacity falls → LRAS shifts LEFT. EXAMPLE: North Sea oil discovery → UK LRAS shifted right. Deforestation and soil degradation → agricultural productive capacity falls → LRAS shifts left in affected economies.

Determinants of SHORT-RUN AGGREGATE SUPPLY (SRAS) — overview

SRAS slopes upward (when wages are sticky). It shifts when PRODUCTION COSTS change for reasons other than the domestic price level. A rightward shift = increase in SRAS (more output supplied at every price level). A leftward shift = decrease in SRAS. The DOMESTIC PRICE LEVEL causes movement ALONG SRAS (not a shift). Key shifters: costs of inputs (especially wages), supply shocks, government policies affecting costs.

Wages and labour costs — determinant of SRAS

WHAT IT DETERMINES: position of SRAS curve. HOW: RISING wages → production costs rise → firms supply less at every price level → SRAS shifts LEFT. FALLING wages → costs fall → SRAS shifts RIGHT. Wages are the most important determinant of SRAS in the short run because labour is typically the largest cost for most firms. EXAMPLE: Trade union wage settlements exceed productivity growth → SRAS shifts left → inflationary pressure. Wage moderation (Germany Hartz IV 2003) → SRAS shifted right → improved competitiveness.

Commodity and raw material prices — determinant of SRAS

WHAT IT DETERMINES: position of SRAS. HOW: RISING commodity prices (especially oil) → energy and input costs rise for virtually all firms → SRAS shifts LEFT. FALLING commodity prices → costs fall → SRAS shifts RIGHT. EXAMPLE: 1973 OPEC oil embargo → oil price quadrupled → SRAS shifted dramatically left → stagflation across all developed economies. 2022 energy crisis (Russia/Ukraine) → natural gas prices rose 400% → SRAS shifted left → Eurozone inflation surged.

Supply shocks — determinant of SRAS

WHAT IT DETERMINES: position of SRAS (sudden, large shift). HOW: NEGATIVE supply shock (sudden rise in input costs or disruption to production) → SRAS shifts LEFT → higher prices AND lower output → STAGFLATION. POSITIVE supply shock (sudden fall in input costs) → SRAS shifts RIGHT → lower prices AND higher output. EXAMPLE: COVID-19 global supply chain disruption → negative supply shock → SRAS shifted left in all economies. Shale oil revolution (USA, 2010s) → energy costs fell → positive supply shock → US SRAS shifted right.

Exchange rate — determinant of SRAS

WHAT IT DETERMINES: position of SRAS. HOW: DEPRECIATION of domestic currency → cost of imported inputs (raw materials, energy, machinery) rises in domestic currency → production costs rise → SRAS shifts LEFT. APPRECIATION → imported input costs fall in domestic currency → SRAS shifts RIGHT. EXAMPLE: Sterling depreciated post-Brexit vote → UK import prices rose → UK firms' input costs rose → SRAS shifted left → UK inflation rose (cost-push).

Indirect taxes on producers — determinant of SRAS

WHAT IT DETERMINES: position of SRAS. HOW: INCREASE in indirect taxes on businesses (VAT, excise duty, carbon tax) → raises effective production costs → SRAS shifts LEFT. REDUCTION in indirect taxes → costs fall → SRAS shifts RIGHT. EXAMPLE: Introduction of sugar tax → beverage firms face higher effective production costs → SRAS of sugar drinks shifts left. Carbon tax on firms → energy-intensive firms face higher costs → SRAS shifts left.

Subsidies to producers — determinant of SRAS

WHAT IT DETERMINES: position of SRAS. HOW: Government SUBSIDY to producers → reduces their production costs → SRAS shifts RIGHT (more output supplied at every price level). REMOVAL of subsidy → costs rise → SRAS shifts LEFT. EXAMPLE: Government subsidises renewable energy producers → their costs fall → SRAS of renewable energy shifts right. Agricultural subsidies → farming costs effectively lower → SRAS of agricultural goods shifts right.

Government regulations — determinant of SRAS

WHAT IT DETERMINES: position of SRAS. HOW: STRICTER regulations (higher environmental or safety standards) → compliance costs rise → production costs rise → SRAS shifts LEFT. DEREGULATION → compliance costs fall → SRAS shifts RIGHT. EXAMPLE: EU emissions regulations require factories to install expensive filtration → SRAS of affected industries shifts left. Thatcher deregulation (1980s) → reduced compliance costs for UK businesses → SRAS shifted right over time.

Determinants of the CURRENT ACCOUNT BALANCE — overview

The current account balance = Trade in goods + Trade in services + Primary income + Secondary income. Factors that determine whether a country runs a surplus or deficit. Key determinants affect either EXPORTS (credits) or IMPORTS (debits) or income flows.

Exchange rate — determinant of CURRENT ACCOUNT

WHAT IT DETERMINES: current account balance (via trade in goods and services). HOW: DEPRECIATION → exports cheaper (X rises) AND imports more expensive (M falls) → (X−M) rises → CA improves (subject to Marshall-Lerner condition and J-curve timing). APPRECIATION → X falls, M rises → CA worsens. EXAMPLE: UK pound depreciation post-2016 → partial improvement in trade balance (though limited by inelastic demand and Brexit NTBs).

Relative income levels — determinant of CURRENT ACCOUNT

WHAT IT DETERMINES: current account balance (via imports). HOW: HIGHER domestic income → more spending including on imports → M rises → CA worsens. HIGHER foreign income → more foreign spending on domestic exports → X rises → CA improves. EXAMPLE: UK's rapid growth → higher M → persistent CA deficit. China's growth → huge export demand from rising middle class buying Western goods → some CA surplus improvement.

Relative inflation rates — determinant of CURRENT ACCOUNT

WHAT IT DETERMINES: current account balance (via price competitiveness of exports and imports). HOW: LOWER domestic inflation than trading partners → domestic goods become relatively cheaper → X rises, M falls → CA improves. HIGHER domestic inflation → goods less competitive → X falls, M rises → CA worsens. EXAMPLE: Germany's low inflation within eurozone → persistent export competitiveness → large CA surplus. Greek high inflation pre-crisis → lost competitiveness → large CA deficit.

Non-price competitiveness — determinant of CURRENT ACCOUNT

WHAT IT DETERMINES: export performance and current account balance. HOW: higher quality goods, better design, stronger brands, superior after-sales service, technological sophistication → EXPORTS RISE even without lower prices → CA improves. EXAMPLE: Germany exports high-quality cars and machinery → strong non-price competitiveness → CA surplus. UK manufacturing declined in non-price competitiveness → persistent CA deficit despite exchange rate changes.

National saving rate — determinant of CURRENT ACCOUNT

WHAT IT DETERMINES: current account balance (via the saving-investment identity: CA = Saving − Investment). HOW: HIGH national saving (household + corporate + government) relative to domestic investment → surplus saving lent abroad → CA SURPLUS. LOW saving relative to investment → must borrow from abroad → CA DEFICIT. EXAMPLE: Germany high saving rate → CA surplus. USA low household saving rate → persistent CA deficit. China's ~45% savings rate → large CA surplus.

Determinants of the EXCHANGE RATE (floating) — overview

Under a floating exchange rate, the value of a currency is determined by supply and demand in the foreign exchange market. Factors that increase DEMAND for the currency → appreciation. Factors that increase SUPPLY → depreciation. Most important short-run determinant: interest rate differentials (hot money). Most important long-run determinant: purchasing power parity (relative inflation rates).

Interest rate differentials (hot money) — determinant of EXCHANGE RATE

WHAT IT DETERMINES: the value of a floating exchange rate (most important short-run determinant). HOW: HIGHER domestic interest rates relative to abroad → foreign investors buy domestic currency to invest in higher-return domestic assets → demand for domestic currency RISES → currency APPRECIATES. LOWER relative rates → capital outflows → demand falls → currency DEPRECIATES. EXAMPLE: ECB rate rises (2022–23) → euro demand rose → euro appreciated. Fed rate rises (same period) → even larger USD demand → USD appreciated vs most currencies.

Relative inflation rates — determinant of EXCHANGE RATE (long run)

WHAT IT DETERMINES: the long-run value of a floating exchange rate (PPP theory). HOW: country with HIGHER inflation → domestic goods become relatively more expensive → exports fall, imports rise → supply of domestic currency rises (to pay for imports) and demand falls → currency DEPRECIATES. Lower inflation → currency APPRECIATES in real terms. EXAMPLE: UK's historically higher inflation than Germany → long-run sterling depreciation trend against the deutschmark and euro. Purchasing Power Parity theory: exchange rate adjusts to equalise purchasing power.

Speculation and market expectations — determinant of EXCHANGE RATE

WHAT IT DETERMINES: value of floating exchange rate (particularly short-run). HOW: if speculators EXPECT currency to appreciate → buy now → demand rises → it DOES appreciate (self-fulfilling). If expect depreciation → sell now → supply rises → it DOES depreciate. EXAMPLE: Soros and other speculators sold sterling aggressively in 1992 expecting it to leave ERM → selling pressure → Bank of England forced to abandon peg → pound fell 15%.

Current account balance — determinant of EXCHANGE RATE

WHAT IT DETERMINES: long-run pressure on floating exchange rate. HOW: persistent CA DEFICIT → more domestic currency supplied (to pay for imports) than demanded (from exports) → downward pressure on currency → DEPRECIATION. Persistent CA SURPLUS → currency APPRECIATION pressure. EXAMPLE: UK's persistent CA deficit → long-run sterling depreciation pressure. Germany's CA surplus → long-run euro appreciation pressure (partially offset by eurozone members' deficits).

Foreign investment flows (FDI and portfolio) — determinant of EXCHANGE RATE

WHAT IT DETERMINES: value of floating exchange rate. HOW: strong INFLOWS of FDI and portfolio investment → foreigners must buy domestic currency → demand rises → currency APPRECIATES. OUTFLOWS → domestic currency sold → supply rises → DEPRECIATES. EXAMPLE: USA attracts massive foreign portfolio investment (world's safe-haven asset → USD demand high → USD remains strong despite large CA deficit).

Political stability and confidence — determinant of EXCHANGE RATE

WHAT IT DETERMINES: value of floating exchange rate. HOW: POLITICAL STABILITY and strong institutions → investors confident → capital inflows → currency APPRECIATES. INSTABILITY, elections, geopolitical risk → capital flight → currency DEPRECIATES. EXAMPLE: Swiss franc (CHF) → safe-haven currency → appreciates during global crises as investors seek safety (even if Swiss interest rates are negative). Turkish lira → political instability and central bank interference → dramatic depreciation.

Determinants of INVESTMENT (I) — determinant of AD and LRAS

WHAT IT DETERMINES: level of investment spending (component of AD; also drives LRAS over time). KEY DETERMINANTS: (1) Interest rates — lower rates → cheaper borrowing → I rises. (2) Business confidence (animal spirits) — most volatile determinant. (3) Expected future demand — higher expected demand → more capacity investment. (4) Corporate taxes — lower taxes → more post-tax return → I rises. (5) Technology — new technologies create profitable investment opportunities. (6) Capacity utilisation — high utilisation → investment to expand capacity. (7) Government policy — investment incentives, R&D subsidies, infrastructure. MOST IMPORTANT: business confidence and interest rates. DIAGRAM: Investment is a component of AD — change in I shifts AD left or right.

Determinants of CONSUMPTION (C) — determinant of AD

WHAT IT DETERMINES: level of household consumption spending (largest component of AD). KEY DETERMINANTS: (1) Disposable income — most important. (2) Consumer confidence. (3) Wealth — asset prices (houses, shares) — wealth effect. (4) Interest rates — affect mortgage costs and return on saving. (5) Credit availability — ease of borrowing. (6) Expectations of future income. (7) Income distribution — lower-income households have higher MPC → redistribution toward poor increases C. DIAGRAM: Change in C shifts AD left or right. Higher MPC → larger multiplier effect of any income change.

Determinants of NET EXPORTS (X−M) — determinant of AD

WHAT IT DETERMINES: net export component of AD. KEY DETERMINANTS: (1) Exchange rate — depreciation improves (X−M); appreciation worsens it. (2) Relative inflation rates — higher domestic inflation → less competitive → X falls, M rises. (3) Foreign income levels — higher foreign income → more X. (4) Trade policy — tariffs reduce M; foreign tariffs reduce X. (5) Non-price competitiveness — quality, design, brand → affects X independently of price. (6) Domestic income — higher domestic income → more M. DIAGRAM: Change in (X−M) shifts AD left or right.

Determinants of the NATURAL RATE OF UNEMPLOYMENT (NRU)

WHAT IT DETERMINES: the level of the NRU (and therefore the position of the LRPC). HOW — factors that INCREASE the NRU: (1) Generous unemployment benefits → longer search times → more frictional unemployment. (2) Skills mismatch / rapid structural change → more structural unemployment. (3) Minimum wage above equilibrium → some workers priced out → real wage unemployment. (4) Geographic immobility of labour → workers in depressed areas cannot easily relocate. (5) Strong unions maintaining wages above clearing level. HOW — factors that REDUCE the NRU: (1) Better job matching information (job centres, online platforms). (2) Retraining and education programmes → reduce skills mismatch. (3) Labour market flexibility → easier to hire and fire → firms hire more readily. (4) Reduced benefit generosity or duration → shorter search times. DIAGRAM: Rightward shift of LRPC (NRU rises) or leftward shift (NRU falls). Only supply-side policies can shift the LRPC.

Determinants of INCOME DISTRIBUTION / INEQUALITY (Gini coefficient)

WHAT IT DETERMINES: degree of income inequality (Gini coefficient, shape of Lorenz curve). FACTORS THAT INCREASE INEQUALITY: (1) Skill-biased technological change → premium for high-skilled workers widens. (2) Globalisation → downward pressure on low-skilled wages in developed countries. (3) Decline of trade unions → reduced worker bargaining power. (4) Reduced top marginal tax rates → post-tax inequality rises. (5) Returns to capital exceeding growth rate (Piketty: r > g) → wealth concentration. (6) Inheritance → intergenerational transmission of wealth. FACTORS THAT DECREASE INEQUALITY: (1) Progressive taxation. (2) Transfer payments (pensions, benefits). (3) Universal public services (education, healthcare). (4) Minimum wage. (5) Strong trade unions. (6) Wealth and inheritance taxes. DIAGRAM: Lorenz curve bows MORE away from 45° line as inequality rises; Gini coefficient rises.

Determinants of ECONOMIC GROWTH (real GDP growth rate)

WHAT IT DETERMINES: rate of real GDP growth over time. DEMAND-SIDE (short-run): C, I, G, (X−M) — rising AD drives actual growth when spare capacity exists. SUPPLY-SIDE (long-run): (1) Labour force growth and quality (human capital). (2) Physical capital accumulation (investment). (3) Technological progress (TFP growth — most important long-run driver). (4) Institutional quality (property rights, rule of law). (5) Natural resources (quantity and quality). (6) Infrastructure quality. DIAGRAM: PPC shifting outward (long-run growth). LRAS shifting rightward. AD shifting right (short-run growth using spare capacity). Growth rate = % change in real GDP = (New real GDP − Old real GDP) ÷ Old real GDP × 100.

Determinants of the MULTIPLIER SIZE

WHAT IT DETERMINES: the size of the fiscal multiplier (k) — how much GDP changes per unit of initial injection. FORMULA: k = 1 ÷ (MPS + MPT + MPM). FACTORS MAKING MULTIPLIER LARGER: (1) Lower MPS (higher MPC) — less income leaked into saving. (2) Lower MPT — less income leaked into taxes. (3) Lower MPM — less income leaked into imports (less open economy). (4) Spare capacity in economy — output can respond to demand without inflation. (5) Low interest rates — no crowding out. FACTORS MAKING MULTIPLIER SMALLER: (1) Higher MPS, MPT, MPM — more leakages. (2) Economy near full employment — more spending goes to prices not output. (3) Crowding out — government borrowing raises interest rates → private I falls. (4) Ricardian equivalence — households save tax cuts. (5) Very open economy — high MPM → most of stimulus leaks abroad.

Determinants of INFLATION

WHAT IT DETERMINES: the rate of inflation (% change in CPI). DEMAND-PULL DETERMINANTS: anything that increases AD faster than AS (excess demand). (1) Falling interest rates → C and I rise. (2) Rising government spending or tax cuts. (3) Rising confidence. (4) Currency depreciation → import prices rise (via SRAS) AND exports rise (via AD). COST-PUSH DETERMINANTS (shift SRAS left): (1) Rising oil and commodity prices. (2) Rising wages above productivity growth. (3) Currency depreciation → imported input costs rise. (4) Supply chain disruptions. EXPECTATIONS-BASED: (1) Entrenched inflation expectations → wage-price spiral self-sustaining. (2) Excess money supply growth (Monetarist: MV=PQ). DIAGRAM: Demand-pull = AD shifts right along SRAS. Cost-push = SRAS shifts left → stagflation. Both raise price level but for different reasons → different policy responses.