9708 · 4.3
Aggregate Demand and Aggregate Supply flashcards
Revision flashcards for Cambridge 9708 Aggregate Demand and Aggregate Supply (syllabus 4.3). Flip, recall, then mark a real past-paper question.
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Components of aggregate demand?
AD = C + I + G + (X − M) — consumption, investment, government spending, net exports.
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Why does AD slope downward?
Wealth effect (lower P → higher real wealth → more C), interest rate effect (lower P → lower r → more I and C), exchange rate effect (lower P → currency appreciation → fewer exports).
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Why does SRAS slope upward?
As the price level rises, firms' output prices increase faster than input costs (sticky wages), so profit margins rise and firms supply more output.
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What does LRAS represent?
Long-run aggregate supply — vertical at full employment output (Yf), determined by factors of production and technology, independent of price level.
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AD shifts right — effect on P and Y?
Both price level (P) and real GDP (Y) rise in the short run — demand-pull pressure on prices and higher output.
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SRAS shifts left — effect on P and Y?
Price level rises but real GDP falls — stagflation (cost-push inflation with lower output).
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What are the three main reasons for the downward slope of the Aggregate Demand curve?
1. The Wealth Effect: A higher price level reduces the real value of money and assets, decreasing consumption. 2. The Interest Rate Effect: A higher price level increases money demand, raising interest rates and reducing investment. 3. The International Trade Effect: A higher price level makes exports less competitive and imports more attractive, reducing net exports.
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Define 'stagflation' using the AD-AS model.
A period of stagnant economic growth (falling real GDP) combined with rising inflation. It is illustrated on an AD-AS diagram by a leftward (inward) shift of the SRAS curve, leading to a higher equilibrium price level and a lower equilibrium real GDP.
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Distinguish between a movement along and a shift of the SRAS curve.
A movement along the SRAS curve is caused only by a change in the general price level. A shift of the SRAS curve is caused by a change in the economy-wide costs of production, such as changes in nominal wage rates, raw material prices (e.g., oil), or business taxes like VAT.
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What is the key difference between the short run and the long run in the context of aggregate supply?
In the short run, it is assumed that at least one factor cost, typically nominal wages, is fixed or 'sticky'. In the long run, all factor prices are assumed to be fully flexible and have adjusted to any changes in the price level. This is why the SRAS curve is upward sloping, while the LRAS curve is vertical.
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How would a widespread adoption of a new, more efficient production technology affect the AD-AS diagram?
This represents a positive supply-side shock. It lowers the costs of production for many firms and increases the economy's productive potential. This would cause both the SRAS and the LRAS curves to shift to the right, leading to a lower price level and higher real GDP.