3. Changes in these components can change the overall level of aggregate demand Eg. increase in investment increases stock of capital goods, these help produce other goods which leads to increased economic activity in the long term. The components of Aggregate Demand are shown in the expenditure approach. C + I + G + ( X – M) = GDP = AD Consumer Spending – C Investment – I Government Spending – G Export Receipts – X Import Payments – M

7. Component of AD? AD decreases? AD increases? Increased consumer confidence in the future Increases in the price of imports due to exchange rates Government increases the Minimum Wage Central bank increases interest rates Government reduces core spending to avoid a deficit. Indirect taxation on consumer goods is increased from 7-10% Business survey predicts lack of confidence in the future of the economy.

14. Price Level (P L ) Y 1 SRAS 1 SRAS 2 AD 1 AD 2 What happens….. AD increases – leads to increased prices, purchasing power of worker wages falls Workers demand higher wages to maintain purchasing power. Cost of production for the firm increase therefore SR AS shifts to left – Price level rises, no change in output.

15. Price Level (P L ) LRAS SRAS 0 Y Full SRAS 1 SRAS 2 A B C D E As output increases and prices rise in SR this causes movement along the curve (A – B) Workers realise that prices are increasing so demand higher wages to maintain purchasing power. So SRAS 1 shifts upwards. Again firms attempt to increase output and increase prices in the SR. In the LR the prices will rise as output returns back to Y 0 Potential output of the economy depends on productivity (the quality and quantity of factors of production)

16. Price Level (P L ) LRAS Y Full Neo classical economists argue that in the long run the economy will automatically shift to its long run equilibrium. In the Long Run an increase in AD will lead to an increase in the price level but no change to the equilibrium level of output. AD 1 AD 2

17. Price Level (P L ) LRAS Y F SRAS 1 SRAS 2 If there is a change in AD 1 to AD 2 due to changes in the components of AD then in the short run there will be an increase in output from Y F to Y 1 According to neo classicists this is only possible in the SR by paying workers overtime wages to attain Y 1 In the long run there is no unemployed resources, so the prices of all resources will increase due to scarcity. Remember in the short run this leads to an increase in the costs of production which shifts the SRAS curve to the left. LR equilibrium is back to Y F but higher Price level. Potential output of the economy depends on productivity (the quality and quantity of factors of production) AD 1 AD 2 Y 1

18. Consumer Goods Capital Goods These all show the same concept increases in the production capacity in the Long Run Increases in production capacity are created by supply side policies Price Level (P L ) LRAS 1 Real Output LRAS 2 Price Level (P L ) LRAS 1 LRAS 2 Real Output

23. The dotted line represents the economic capacity to sustainably supply goods and services. Overtime as it rises the economy becomes larger. When the actual line is above the potential line the economy is said to have a positive output gap as at point B. Demand exceeds the sustainable capacity thus shortages occur and prices rise (inflation) also called an inflationary gap When the actual line is below the potential line the economy has a negative output gap as at point C. At this point there is spare capacity, higher then average unemployment leading to less inflationary pressures. Also called a recessionary gap . B C

25. Consumption decreases Inflation pressure rises Govt Spending decreases AS increases AD increases AS decreases Investment increases Price level increases Consumption Increases Inflation pressure eases Unemployment falls Real Output Increases Real Output decreases Price level decreases Unemployment increases Investment decreases Govt Spending increases Net Exports increases Net Exports decreases

27. Show the effect of an increase in direct taxes on an aggregate demand and supply graph.

28. Inflationary Gap SRAS greater than LRAS Recessionary Gap SRAS less than LRAS SR AS changes LR AS changes

29. AS AD

30. AS AD

31. Unemployment Output (Y) Inflation (P L ) Boom decreasing increasing Inflationary pressure increasing Peak Very low Highest level but not increasing High inflationary pressure Recession increasing Decreasing Disinflation Depression Very high Lowest level but not decreasing further Potential deflation Recovery Starting to decrease Increasing Small increases in inflation rate.