Variations in economic activity

aggregate demand (AD)

• The total value of all goods and services consumers are willing and able to purchase in an economy over particular time period, at different possible price levels

• calculated using expenditure approach

• if AD increases, economic growth has happened

AD curve

• average price level on y-axis, real GDP on x-axis

• downward sloping

  • changes in average price = movement along AD curve

    • increase in AP = contraction

    • decrease in AP = expansion

movement along AD curve

• changes in average price = movement along AD curve

shifts of entire AD curve

• causes by change in non price determinant of AD

  • increase in non price determinant = shift right

  • decrease in non price determinant = shift left

factors influencing consumption

• consumer confidence

  • the stronger the economy, the higher the consumer confidence

  • consumption increases and saving decreases

• interest rates

  • increased interest rates = greater incentive to save

    • hence less consumption

• wealth

  • consumer wealth increases = consumption increase

• income taxes

  • taxes increase = disposable income decrease

  • hence less consumption

• expectation of future price level

  • if it’s believed prices will rise in future, consumers incentivised to spend now

• indebtedness of household

  • higher debt = less disposable income for consumption

factors affecting investment

• interest rates

  • decreased interest rates = higher investment

• business confidence

  • longer period of economic growth = higher business confidence

• technology

  • when firm identifies new technology which reduces costs and raises output, they’re incentivised to invest

• business taxes

  • higher taxes = less profit = less money for investment

• corporate indebtedness

  • higher debt = less money available for investment

factors influencing gov spending

• political priorities

  • some parties believe the state should provide more goods and spending increases, others believe role of gov in society should be small

• economic priorities

  • depends on fiscal policy

  • expenditure related to gov’s objectives

factors influencing net exports

• income of trading partners

  • household income of trading partners increases = foreigners purchase more products, exports increase

• exchange rates

  • when domestic currency value rises, consumers money can buy more abroad - imports increase

    • exports are also more expensive for foreigners - exports decrease

• trade policies

  • if import tariffs increase, decreased demand for imports

aggregate supply

• total quantity of goods and services produced in an economy over a particular time period, at different price levels

• short run = period which wages and other factors are inflexible

• long run = period in which there is full wage and factor price flexibility

SRAS curve

• upward sloping

  • AS is the combined supply of all individual supply curves

  • as real GDP increases, firms must spend more to increase production

• increase in AP = expansion of real GDP (Y)

• decrease in AP = contraction of real GDP (Y)

shifts of SRAS curve

• decrease in cost/increase in productivity shifts the SRAS curve right

• increase in cost/decrease in productivity shifts SRAS curve left

changes to costs of raw materials - impact on SRAS

• as price of raw materials increase, fewer goods can be made with the same amnt of money

  • SRAS shifts left

• as price of raw materials decrease, more goods can be made with same amnt of money

  • SRAS shifts right

change in indirect taxes - impact on SRAS

• decrease in taxes = decrease in costs = more output

  • SRAS shifts right

• increase in taxes = increase in costs = less output

  • SRAS shifts left

neo classical LRAS

• LRAS is perfectly inelastic at a point of YFe of all available resources

• believe that LRAS will always return to FE, all changes in the LR will be at AP

  • during extreme periods of growth, there can be inflationary gap

    • will self correct and return to LR level, but at higher AP

  • during recessions , can be recessionary gap

    • will self correct and return to LR level but at lower AP

inflationary/recessionary gaps

• inflationary: when real GDP is greater than potential real GDP

• deflationary: when real GDP is less than potential real GDP

deflationary gap neo classical

inflationary gap neo classical

factors that shift LRAS

• changes in quality/quantity of FOP

  • increase in this causes increase in production possibilities (outward shift of PPC

• technology advances

• efficiency improvements

• changes in institution

  • e.g implementation of new legislations, increasing financial institutions

classical LRAS model

• initial equilibrium at A1Yfe

• increase in quality of labour causes LRAS to shift right

• extra supply in economy allows prices to fall and output to increase

• new equilibrium at A2Yfe1