10.4 Aggregate Demand and the Level of Economic Activity

What are the main factors that influence the level of economic activity

• Employment

• Confidence

• Events (e.g. natural disasters, Christmas)

• Taxes + Interest rates

How does employment affect economic activity

It influences production and consumption

What is the multiplier effect

It is the process where an initial increase in aggregate demand leads to a greater final increase in national income

Why does the multiplier effect occurs

Because one person’s spending is another person’s income, creating a chain reaction

Draw the Multiplier Effect

How is the multiplier calculated using the marginal propensity to consume

Multiplier = 1 / (1 - MPC)

How does spare capacity in an economy affect the multiplier

If spare capacity is high (elastic SRAS), the multiplier effect is larger because more output can be produced without causing inflation

What is reverse multiplier effect

A withdrawal of income from the circular flow can lead to a larger decrease in national income, reducing growth