The National and International Economy

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The National and International
Aggregate demand and aggregate supply and their interaction
Aggregate Demand: The total demand for an economy's goods and services at a given price level,
over a period of time. AD = C + I + G + (X-M)
Components of Aggregate Demand:
C ­ Consumer Expenditure: Total spending by consumers/households on consumer goods and
services in a given period of time. Influences: Real disposable income, wealth, consumer confidence,
interest rate, age demographics, distribution of income, inflation.
I ­ Investment Expenditure: Total spending by firms on capital goods in a given period of time.
Influences: Changes in real disposable income, current profit levels, business confidence and
expectations, interest rate, corporation tax, advances in technology, price of capital equipment,
capacity utilisation (spare capacity).
G ­ Government Expenditure: Total spending by government on goods and services in a given
period of time. Influences: Government's view of how much intervention is needed to correct for
market failure, previous spending commitments, amount of tax revenue raised, level of economic
activity, level of borrowing the government is willing to undertake, political motives, policy decisions
to influence macroeconomic performance.
(X-M) ­ Net Exports: Total value of exports ­ total value of imports, in a country, in a given period of
time. Influences: Real disposable income home and abroad, domestic price level, relative inflation
rates, the exchange rate, trade policy decisions.
Aggregate demand and the price level are inversely related ­ as the price level increases,
aggregate demand decreases.
Shifts in aggregate demand: A change in any factor that influences AD, through the effect on the
components of AD, will cause a shift in the AD curve. Possible caused of an increase in AD: Increasing
consumer confidence, increasing government expenditure, reduced taxation, increasing business
confidence, cut in interest rates, increase in the money supply, a fall in the relative value of the
domestic currency, an increases in the size of the population, increases in wealth (assets). Reductions
in AD may be caused by the opposite of the above circumstances.
Aggregate Supply: The total output of goods and services that producers in an economy are willing
and able to supply at a given price level, in a given period of time. The AS curve may shift to the right
due to: A reduction in real wage rates, a fall in raw materials costs, increased factor productivity,
improvements in resource management, technological innovation, lower costs of finance, increases
in quantity and/or quality of resources available to the economy.
Macroeconomic Equilibrium occurs when AD and AS is equal. Total domestic output and price
levels will be stable. No pressure for price level and output to change ­ no inflationary or deflationary
pressure. Equilibrium will change when there are contractions or extensions in AD or AS.
The Circular Flow of Income: The movement of spending and income throughout the economy.

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Leakages: Withdrawals of possible spending from the circular flow of income ­ savings, imports,
taxes. Injections: Additions of extra spending into the circular flow of income ­ investment, exports,
government spending.
The Multiplier Effect: The process by which any change in a component of AD results in a greater
final change in Gross Domestic Product (the total output of goods and services in a country).
The Multiplier = 1/ (1 ­ Marginal Propensity to Consume).…read more

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The expenditure method is as follows: GDP = C + I + G + (X-M). When using the output method,
double counting can occur (e.g. counting the output of raw materials and then including them again in
the value of finished products) and this distorts the result. The existence of an informal economy
(unrecorded economic activity) means that the country's output may be higher than official figures
suggest.…read more

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Structural unemployment: Caused by
the decline of certain industries due to changes to the structure of the economy because of changing
market conditions. Can be serious and long term in nature. Regional unemployment e.g. decline of
heavy industry in a particular area. Loss of jobs due to mechanisation/technological advances.
Outsourcing to other countries ­ shifts in comparative advantage.
Causes of inflation: Cost push inflation: Where the price level is pushed up by sustained increases
in the costs of production shown by a reduction in AS.…read more

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GDP. However it may put downward pressure on inflation. It may also be
welcomed by firms importing products and by people travelling abroad.
The application of macroeconomic policy instruments and the
international economy
Fiscal policy: The taxation and spending decisions of a government. Referred to as a demand side
policy, although it can have significant supply side effects. The government announces its public
spending and taxation decisions in the annual budget ­ budget surpluses, deficits, or a balanced
budget.…read more

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­ designed to reduce
barriers to entry). Interventionist supply side policies: Education (should raise labour productivity
and mobility, state intervention necessary as education is a merit good), training (should also raise
labour productivity and mobility), investment grants (increase the quality and quantity of investment
­ grants to infant industries for example), regional policy (regenerate depressed areas by
incentivising firms to locate in these areas).
International trade: The exchange of goods and services between national economies on the
international market.…read more



This 7 page well written document analyses the macroeconomic indicators and briefly runs through fiscal, monetary and supply side policies for impacting on them.

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