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What is meant by economic activity?
Can mean many things, but we shall think of it as centring on the production and consumption of goods and services in the economy, together with the employment of labour, capital and other inputs that produce output.
What are the factors that influence the level of economic activity?
1. Employment - influenced production and consumption
2. Confidence - influencers the level of spending and investment
3. Events - natural disasters or Christmas influence the level of consumer spending
4. Other factors - such as taxes and interest rates influence how much firms and consumers borrow, save or spend
The effect of a change in aggregate demand on real output on a diagram?
pg 342
The diagram on the left illustrates the effect of an increase in aggregate demand on real output. It shows how a rightward shift of the AD curve leads to an increase in real output. The diagram on the right, by contrast, shows how a leftward shift of the AD curve leads to a fall in real output. To put it another way, the left diagram shows the expansionary effect of an increase in AD, while the right diagram shows the contractionary effect of a decrease in aggregate demand. The expansionary effect is likely to increase employment; the contractionary effect is likely to lead to a fall in employment.
What is the link between aggregate demand and employment?
When real output increases, firms generally have to employ more workers to produce the additional goods and services that the output increase involves. Conversely, when real output falls, less labour is required to produce the smaller amount of goods and services now being produced.
What is the multiplier effect?
Refers to how an initial increase in AD leads to an even bigger increase in national income
When does the multiplier effect occur?
Occurs when there is new demand in an economy. This leads to an injection of more income into the circular flow of income, which leads to economic growth. This leads to more jobs being created, higher average incomes, more spending, and eventually, more income is created.
National income multiplier effect illustrated on an AD/AS diagram?
pg 343
In the diagram, an initial increase in government spending shifts the AD curve from AD1 to AD2. This then triggers the multiplier process, which leads to a further increase in aggregate demand to AD3. If the size of the government spending multiplier is 2.5, then then eventual increase in aggregate demand is two and a half times the size of the initial increase in government spending.
What is the marginal propensity to consume?
The fraction of any increase in income which people plan to spend on the consumption of domestically produced goods and services
What is the marginal propensity to save?
The fraction of any increase in income which people plan to save rather than spend
What is a formula to calculate the multiplier?
1/(1-MPC)
Means if consumers spend 0.6 of every £1 they earn, they save 0.4/ Therefore the multiplier will be:
1/(1-0.6) =.1/0.4 = 2.5
