Aggregate Supply
          and   A ggregate Demand

          Q.1 Define the following terms

          • consumption
          • the marginal propensity to consume
          • the equilibrium level of income
          • aggregate demand
          • the income multiplier

          Q.2 What are the implications of the multiplier process on the equilibrium level of income?

          Q.3 How did the classical economists and the Keynesians disagree on the process followed to reach the equilibrium level of income in our economy?

          Q.4 What are the factors that effect the size of the multiplier?

          Q.5 Outline (with a diagram) the process by which the equilibrium level of income is attained.

          Q.6 Why is the level of stocks held by firms crucial in determining the equilibrium level of production and income in our economy?

          Q.7 How can changes in the Government's Budgetary position (that is, running a deficit or a surplus) effect inflation and employment?

          Q.7(b) Analyse the macroeconomic effects of a fall in interest rates. Follow this link for a suggested answer.

          Q.7(c) Analyse the macroeconomic effects of running a Budgetary surplus, when the economy is already near the full employment level of GDP. Follow this link for a suggested answer.

          Q.8 The diagrams below represent changes in aggregate supply and aggregate demand.

          In the last two quarters of 1992, prices fell and unemployment grew. Which of the diagrams above best illustrates these conditions?

          Follow this link to the answer.

          Q.9 The diagram below represents a possible AS - AD position experienced by the Australian economy. The full employment level of real Gross Domestic Product is indicated by Yf.

          A shift of the aggregate supply curve from AS to AS1 could be caused by :

          J. A large fall in the number of migrants coming to Australia.
          K. A decrease in the general level of interest rates.
          L. A rise in petrol prices from 70 cents per litre to 85 cents per litre.
          M. An increase in the level of imported consumer goods purchased by Australians.

          Follow this link to the answer.

          Q.10 The diagram below represents a possible AS - AD position experienced by the Australian economy. The full employment level of real Gross Domestic Product is indicated by Yf.

          As Treasurer, what would be your response to the change in the economy shown above?

          J. Decrease interest rates and increase government spending
          K. Increase interest rates, cut government spending, and lower tariffs.
          L. Increase tariffs, increase government spending and increase interest rates.
          M. Increase sales of government assets to the private sector.

          Follow this link to the answer.

          Q.11 The movement from AS1 to AS2 could be the result of

          J. increases in production costs caused by wage increases.
          K. increases in taxes levied on businesses by the Federal Government.
          L. the adoption of new technology by firms.
          M. a depreciation of the Australian dollar, causing an increase in the cost of imported capital.

          Follow this link to the answer.

          Q.12 How does microeconomic reform create a long term increase in Aggregate Supply? How does microeconomic reform assist the Government in reaching its macroeconomic objectives?

          AS AD in Action

          Q.1 In the early 1970's, OPEC (the Organisation of Petroleum Exporting Countries), quadrupled the price of oil (that's right, increased the price by 400%). The reasons for this were complex, but one reason was the members of OPEC felt they were being exploited by the oil companies, all of which were foreign owned multinational companies.

          Draw an AS-AD diagram to show the effect on the world economy of an increase in the price of oil. Want a hint?

          Q.2 In 1997, the Howard Liberal government in Australia has announced that one of its main priorities is to reduce Federal Government debt. To reduce debt, the Government has announced that from now on, Budget deficits will be a thing of the past. From now on, the Budget will have an underlying surplus. That is, even after you take out the effects of asset sales (like the privatisation of Telstra, which is included as a ''one off'' addition to Government revenue), the Budget will still be in surplus.

          Draw an AS-AD diagram to show the effect of continuing Budgetary surpluses on unemployment and inflation. Want a hint?

          Q.3 The Labor Party believes that unemployment is a major issue for Australia. Microeconomic reform, that began with Labor's ''Accord'', has lead to a more efficient labour market, as Awards are simplified and restrictive practices (that lead to higher costs of production) are removed. The economy can afford a fiscal stimulus (that is, a small Budgetary deficit), as such a stimulus would not increase inflation by any great degree.

          Draw an AS-AD diagram of our economy that would support the Labor Party's argument. Want a hint?

          Q.4 The Howard Government believes the labour market still contains significant structural problems. Strong unions still have too much power, and are able to gain wage rises for their members that are greater than could be justified on productivity grounds. (That is, unions may agree to changes in work practices that increase output per day by 2%, but the unions are demanding a wage rise of 6%, in return for accepting the new conditions).

          Draw an AS-AD diagram of our economy that would support the Liberal Party's argument. Want a hint?

          Q.5 Outline the effects of a fall in consumer confidence in the future performance of our economy on production and employment. Draw a diagram to support your answer.

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