chapter 6
circular flow of income`
aggregate demand and factors affecting it
aggregate supply and factors affecting it
equilibrium level of national output and general price level
multiplier effect on AD
total withdrawals = total injections
withdrawals: when any part of income is not used to buy domestic goods and services
injections: an addition of spending to the circular flow of income, expenditure on domestic goods and services other than consumption expenditure
investments, government expenditure, exports
savings, taxes, imports
AD: the total value of domestically produced final goods and services demanded by households, firms, the government and foreign countries at each price level at a given time period
AD = C + G + I + X - M
factors affecting Consumption
income determinant: induced determinant
when talking about changes in AD, always consider autonomous factor instead of induced one (aka income determinant)
autonomous determinant (non-income)
less money, less demand
fiscal policy : if govt raises income tax then disposable income fall and consumption falls
changes in interest rates: if interest rates fall, cost of borrowing fall and consumers are encouraged to borrow more to spend more. this also means that the returns on saving is lower so individuals may increase current consumption
income and wealth distribution: if value of consumers other assets such as houses, cars, etc increases, consumers confidence increases and cause consumers expenditure to increase
expectation: if prices are gonna increase, consumers will buy goods right now
marginal propensity diminishes with increasing income (coz they alr have the things they need, so no need to buy more)
more money, average propensity to save increases and average propensity to consume decreases
factors affecting Investment
interest rate: high interest rate, higher cost of borrowing, more expensive for firms to finance projects. rate of return on investment also falls and investment is thus less profitable, so firms will reduce investment
expectations: if business prospects is good then firms will increase their investment ot expand their productive capacity
costs and efficiency of capital inputs: if technology improves such that capital becomes more efficient and returns from investment increases then firms will increase investment
government policy: if government has pro-business policy such as low carbon tax, corporate tax etc then firms will be more likely to invest in the economy as after-tax profitability of the firms remain high
government expenditure: independent on level of national income revenue --> autonomous
can run on budget deficit (spends more than taking in) or budget surplus (take in more than spend out)
factors affecting exports and imports
income at home or abroad : link to demand for whose goods, always take the stand of sg
FACTORS THAT SHIFT THE AD CURVE
changes in economic outlook: affects level of investment
changes in interest rates: affect investment and consumptions
changes in foreign incomes: affect exports level
AS: total value of final goods and services firms in an economy would like to produce at difference general price level
SRAS
LRAS
factors affecting sras
determined by the productive capacity of the economy. Yf is the long run equilibrium output at full employment level (straight line)
factors affecting LRAS (QQT)
COST OF PRODUCTION: price of inputs such as materials, wage
short terms supply shocks: due to bumper harvests and natural disasters/ supply chain disruption
quantity - capital stock: if firms have high capital stock then firms can produce more goods and services. this can be affected by the level of investment firms put in.
quantity/ quality - labour force: expanded labour force who are more skilled will increase economy's potential output
technology - changes in productivity of factors of productions: better machinery and equipment --> more output but with the same amount of resources --> long term increase in LRAS
long term destruction/ loss of factors of production
major earthquakes/ wars may cause loss of physical capital -> fall in productive capacity and leftward shift of LRAS
LRAS SHIFT RIGHT/LEFT + need to indicate YF
SRAS SHIFT UP/ DOWN
condition for equilibrium : when planned AD exactly equals to AS
numerical coefficient by which an autonomous change in AD is multiplied to show the final change in national income
assumption: there is a slot of spare capacity in the economy. assume that marginal propensity to consume domestically produced goods is 0.X value (take 0.6)
rationale: expenditure creates income and incomes generates expenditure
EXPLAIN PERIOD BY PERIOD FOR AT LEAST 2 PERIODS
in the first period, the initial increase in AD, as illustrated by the shift from AD0 to AD1, will result in an increase of $100 millions which leads to an increase in induced consumption of $60 millionby workers and businesses as MPCd=0.6
the $60 million increase in consumption will crease $60million of new output and income for firms and workers to be spent in period 2. this is illustrated in the shift of AD1 to AD2, where firms and workers increase their consumption by $36mil which results in more output and income again. This is shown by AD3
MORE EACH SUCCESSIVE ROUND, THE INCREASE IN INCOME GETS SMALLER BECAUSE OF LEAKAGES AND THE MULTIPLIER PROCESS WILL STOP WHEN WITHDRAWALS = INJECTIONS and the economy has returned to equilibrium but at a lower level
multiplier = 1/(1-MPCd) --> if mpcd=0.6 then multiplier value is 2.5, leading to a total of $250mil generated from initial increase of $100mil, showing that the initial increase in autonomous expenditure has led to a more than proportionate increase national income
factors affecting magnitude of change in national income
size of initial change in AD
size of multiplier effect
leakages in the economy (like savings, taxes)
state of the economy: real national income may not increase by the full multiplier effect of economy is already at nearing full employment level as there is also an increase in general price