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Define aggregate demand
the total spending of goods and services in an economy over a given period of time
What is the formula for aggregate demand?
Consumer Spending + Investment by firms + Government Spending + (Exports - Imports)
C + I + G + (X-M)
Aggregate Demand Graph, why its sloping downward
Because When price levels fall, more people in an economy are willing and able to purchase more goods and services
At lower price levels, British goods become more competitive so exports increase and imports fall.
When does the AD curve shift?
It shifts when affected by other factors than price level changes. Any factor that affects the CGIXM causes AD curve shifts
define consumer spending
the total amount spent by households on goods and services.
What Five factors affect levels of consumer spending in an economy?
Income- Higher income= increased ability to buy G&S
Employment- more confident if secure in employment so spend more.
Confidence- more confidence in economy & job = spend more save less.
Interest Rates- higher interest rates = more saving, less loans & credit card use, less spending
Taxes- increase in NI contributions/ income tax = less net income= less ability to spend on G&S.
What is Investment by Firms?
Money spent on assets by firms which they will use to produce goods and services
e.g. machinery, factories, computers etc.
What are three factors that affect investment by firms in an economy?
Interest rates: firms may require loans to cover investment. High interest rates= increased cost of borrowing= increase in required rate of return for investment= marginal propensity to invest falls.
Business Confidence: if businesses are confident in future profits from investment, and demand in economy, businesses are more likely to invest- marginal prop. to invest increases.
Government incentives: cut in corporation tax/subsidies/relaxation of regulations= firms have greater financial resources to fund investment.
Define government spending
Money spent by the government on the services it provides, such as healthcare.
Government spending consists of the combined capital and current spending of central and local governments.
What is capital spending in relation to government spending?
Capital spending is investment spending on increasing your fixed assets, for example, building a hospital, buying equipment or building a new road.
What is current spending in relation to govt. spending?
Current spending is expenditure on day to day running costs, for example, government spending on wages of public sector workers.
what is one major difference between capital and current spending?
One major difference is that capital spending will leave you with assets (e.g. roads, factories, schools).
If necessary, these assets could be later sold to recoup some of the capital investment.
With current spending, you don’t have any assets or any way of recouping the payments (you can’t ask nurses to pay back their wages)
Define exports
goods and services that are produced in the UK and then sold in another. They create an inflow of money into the UK
Define imports
goods or services produced in another country, then sold in the uk. They see money flowing out of the UK
What is net exports?
exports - imports.
What 4 factors affect the level of net exports?
Exchange rate: strong pound= imports cheaper, exports more expensive & vice versa
Domestic Incomes: Higher incomes= able to buy more G&S- some will be purchased abroad= higher imports
Foreign Incomes: Foreign households may have a greater ability to buy G&S and may choose to buy from UK- rise in exports
Protectionism: higher tariffs makes imported goods more expensive compared to domestic goods= rise in net exports.
Define the multiplier effect
the process by which an initial injection of spending( in components of AD- G,I,X,M) leads to a greater final increase in national income (GDP).
This occurs because one person’s spending becomes another person’s income, leading to further rounds of spending and income generation.
Define the Marginal Propensity to consume
is the proportion of any additional income that is spent on consumption rather than saved
MPC= Change in consumption / Change in income
What is the Marginal Propensity to consume formula?
MPC= Change in consumption / Change in income
For example, if a person receives an extra £100 in income and spends £80 of it while saving £20, the MPC would be:
MPC= 80 / 100 = 0.8
What does a higher MPC mean for the multiplier effect?
The higher the MPC, the stronger the multiplier effect, because more money keeps flowing through the economy. If people save too much, the multiplier effect weakens because the money doesn’t get spent and passed on.
what is the formula for the Multiplier size?
the ratio of the change in GDP to the injection that brought it about.
1 / 1-MPC
define the MPW
the proportion of any extra income that leaves the economy instead of being spent on goods and services. Can be withdrawn from the economy by:
being saved
taxes
imported goods
leakages in the economy
formula for MPW
MPW=MPS+MPT+MPM
(propensity to save, tax and import)
What is the accelerator effect?
that investment by businesses increases when national income rises and AD rises.
How does the accelerator effect work? 4 steps
Increase in Aggregate Demand (AD): When consumer spending, government expenditure, or exports rise, firms experience higher demand for their goods and services.
Firms Increase Investment: To meet this rising demand, firms invest in new capital goods (e.g., machinery, factories, technology) to expand production.
Multiplier Interaction: The increased investment itself leads to further increases in AD, contributing to a positive cycle of growth.
What is aggregate supply?
the total volume of goods and services that domestic firms are willing and able to supply over a given time period and at a given price level.
Explain the Classical Short Run Aggregate Supply Curve
It is upward sloping because firms respond to higher prices by increasing output.
This happens because, in the short run, at least one factor of production (such as wages) is fixed, meaning firms can’t instantly adjust all costs.
When does the classical SRAS curve shift?
Any change in production costs will shift the SRAS curve:
Rightward Shift (Increase in SRAS)
changing wage costs
price change of raw materials
changes in value of currency
What does the classical LRAS curve show?
the total output an economy can produce when all resources are fully employed—working at full productive potential capacity.
In the long run, all factors of production can be adjusted to an equilibrium, so the economy is producing at its full potential
Explain the classical LRAS curve— why it is vertical
The LRAS is vertical—an increase in price level causes no change to output because the economy is running at full capacity.
what causes a shift to the LRAS curve?
changes to availability of factors of production or changes to productivity of the current factors of production:
technological advances
improved education
inward migration
discovery of natural resources, etc.
When is classical macroeconomic equilibrium achieved? (graph)
when aggregate supply = aggregate demand
define structural unemployment
Unemployment that happens when workers' skills don’t match the jobs available, or when industries decline due to changes in technology, consumer preferences, or the economy.
It’s usually long-term because workers need to retrain or move to new industries.
Example: Workers in coal mining losing jobs as demand for coal decreases due to cleaner energy sources.
define frictional unemployment
Unemployment that occurs when people are between jobs or are entering the workforce for the first time. It happens as workers search for a job that matches their skills or move from one job to another.
This type of unemployment is usually short-term and occurs naturally in a healthy economy.
Example: A recent graduate looking for their first job or someone who quit their old job to find a better one.
define cyclical unemployment
Unemployment that occurs due to a decrease in overall economic demand during a recession or economic downturn. When businesses produce less because of reduced consumer spending, they may lay off workers, leading to cyclical unemployment.
It rises during periods of economic decline and falls when the economy improves.
Example: A factory worker losing their job during a recession because the demand for the factory’s products drops.
Explain the Keynesian AS curve
The AS curve is elastic (flat) at low levels of output because there is ample spare capacity in the economy- output can expand quickly without a rise in price level to match AD1
As the economy moves closer to full employment of FoP, the curve becomes more inelastic. As the economy approaches full employment, resources become more fully utilised, and firms face higher costs to hire more workers or expand production. In this range, any increase in aggregate demand leads to higher prices (inflation) because businesses have to offer higher wages and use more expensive resources to increase production.
When the economy reaches its maximum potential output (i.e., full employment), the AS curve becomes vertical, meaning that no more output can be produced, regardless of the price level. In this range, any increase in demand will only lead to inflation and no increase in real output because the economy cannot produce more goods and services.
What is the shape of the Keynesian AS curve at low levels of output?
The Keynesian AS curve is horizontal at low levels of output, indicating that the economy can increase output without causing inflation due to idle resources.
What happens to the Keynesian AS curve as the economy moves toward full capacity?
As the economy approaches full capacity, the Keynesian AS curve becomes upward sloping. In this region, increasing demand causes both higher output and higher prices (inflation).
What does the vertical portion of the Keynesian AS curve represent?
The vertical portion of the Keynesian AS curve represents the economy at full capacity. At this point, no additional output can be produced, and any increase in demand only leads to inflation.
Why is the horizontal portion of the Keynesian AS curve significant?
it suggests that in times of economic downturn or recession, increasing aggregate demand (e.g., through government spending) can boost output without causing inflation due to unused resources.
What happens to the economy when it reaches the upward sloping portion of the Keynesian AS curve?
When the economy reaches the upward sloping portion, further increases in demand lead to both higher output and higher prices (inflation), as resources become more fully utilised.
What happens in shifts of AD
When AD increases, price levels rise and output & employment rises
When AD falls, price levels fall and output & employment fall
What happens in shifts of AS?
Increase in productive capacity= higher growth and relieves inflationary pressures.
What is classical macroeconomic self correction?
the idea of self-correction suggests that the economy will naturally return to full employment and potential output over time, without the need for government intervention. The economy has built-in mechanisms that restore balance when it is not operating at full capacity.
(see booklet for 3 examples)
What do classical macroeconomists believe in times of recession?
the economy will naturally self correct over time.
