Macroeconomics: economic activity, AD/AS and objectives
What this domain tests
Macroeconomic activity, AD/AS and objectives. You need the circular flow, AD components, short-run and long-run AS, gaps, and the meaning of growth, unemployment, inflation and the balance of payments.
Core rules
- AD = C + I + G + (X - M). A fall in interest rates, confidence or wealth can raise C/I; fiscal policy affects G/T.
- SRAS slopes upward because costs are sticky; LRAS is vertical at potential output (full employment).
- Equilibrium output can be below (deflationary gap) or above (inflationary gap) potential.
- Objectives: low unemployment, price stability, sustainable growth, balance of payments stability, and often equity.
Worked example
C = 500, I = 120, G = 180, X = 100, M = 140. AD = 500 + 120 + 180 + 100 - 140 = 760. If potential output is 800, there is a deflationary gap of 40. With MPC = 0.8, multiplier = 1/(1-0.8)=5. An injection of 8 raises equilibrium output by 40, closing the gap-assuming spare capacity and no offsetting leakages.
Traps
A change in price level causes movement along AD, not a shift. LRAS shifts with technology, resources or institutions; SRAS shifts with input costs. Real GDP adjusts for inflation; nominal does not. Unemployment can be structural even when AD is high, so demand policy may not fix it.