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UNIT 2The National Economy

2.2

How the Macroeconomy Works

Test 2

In the model of the circular flow of income…


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saving and exports are leakages.saving and exports are leakages.

taxes and investment are injections.taxes and investment are injections.

investment and exports are injections.investment and exports are injections.

leakages equal exports.leakages equal exports.

In the circular flow model, not all income is spent; some leaks from the flow, specifically, saving, imports, and taxes. Similarly, not all spending comes from households; some comes from government, investment, and exports. Only option D identifies these features correctly.

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Question 1Question 1

AQA AS Economics Unit 2 – The National AQA AS Economics Unit 2 – The National EconomyEconomy

A shift of an aggregate demand curve to the left will result in…


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lower output and a higher price level.lower output and a higher price level.

lower output and a lower price level.lower output and a lower price level.

a lower price level and higher output. a lower price level and higher output.

a higher price level and high real GDP.a higher price level and high real GDP.

A shift to the left in aggregate demand will result in movement down the aggregate supply curve, a lower price level, and lower real GDP (ie output). Hence, option B is the correct response.

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Changes in short-run aggregate supply can be caused by changes in…


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the population.the population.

the quality of UK infrastructure.the quality of UK infrastructure.

net immigration from the EU.net immigration from the EU.

raw material prices.raw material prices.

The main factors that affect aggregate supply, in the short-run, are related to changes in the cost of production. Hence, option C, which affects the costs of manufacturers in particular, is the correct response.

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The UK government has been keen to invest in education because it will reduce aggregate demand, and increase economic output.…


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reduce aggregate demand, and increase economic output.reduce aggregate demand, and increase economic output.

increase short-run aggregate supply, and reduce the price level.increase short-run aggregate supply, and reduce the price level.

increase economic growth, by increasing government spending.increase economic growth, by increasing government spending.

lead to a shift to the right in the aggregate supply curve, thereby increasing economic growth.

lead to a shift to the right in the aggregate supply curve, thereby increasing economic growth.

By investing in education, the UK government hopes to improve the productive potential of the UK labour force, which in turn will shift the long-run aggregate supply curve to the right, and increase UK economic growth. Hence, option C is the correct response.

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A demand shock will NOT result in…


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a change in the price level.a change in the price level.

a movement along the aggregate demand curve.a movement along the aggregate demand curve.

a change in real output.a change in real output.

a shift in the aggregate demand curve.a shift in the aggregate demand curve.

A demand shock is an unanticipated event that affects aggregate demand, at all price levels, and therefore causes a shift in aggregate demand, and changes in the equilibrium price level and real output. However, a movement along the aggregate demand curve will be caused by a shift in aggregate supply. Hence, option B is correct.

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A fall in the productivity of labour in an economy will lead to…


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a decrease in the price level.a decrease in the price level.

movement down the aggregate demand curve.movement down the aggregate demand curve.

a fall in the rate of growth of the labour force.a fall in the rate of growth of the labour force.

a leftward shift in the aggregate supply curve.a leftward shift in the aggregate supply curve.

A fall in the productivity of labour will be reflected in an increase in business costs, which in turn can be illustrated with a leftwards shift in the short-run aggregate supply curve. Hence, option C is the correct response.

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Which of the following is most likely to shift the short-run aggregate supply curve to the left?


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An increase in investmentAn increase in investment

A rise in money wagesA rise in money wages

An increase in unemploymentAn increase in unemployment

An increase in capital productivityAn increase in capital productivity

A shift to the left in short-run aggregate supply means that businesses need a higher price level to supply the same amount. This may have arisen because of an increase in money wages. Hence, option B is the correct response.

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The diagram below illustrates the consequences of changes in the conditions of aggregate demand and aggregate supply. Initially, equilibrium is a point E, where SRAS1 intersects with AD1. This economy experiences a 5% reduction in commodity prices, and investment increases by 5%. As a result, equilibrium will…


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move to point C.

move to point C.

move to point B.

move to point B.

move to point D.

move to point D.

stay at point E.stay at point E.

The 5% reduction in commodity prices will reduce business costs and thereby cause a shift downwards in the SRAS curve down from SRAS1 to SRAS2. This is because business will be prepared to supply the same amount of their products at lower market prices. At the same time, a 5% rise in investment will shift the AD curve upwards from AD1 to AD2, because investment is a component of Aggregate Demand. Taking both changes into account, the new equilibrium will be at point C. Hence, A is the correct response.

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Real National Output

AD2

AD1

O

SRAS1

SRAS2

B

C

D

E

PriceLevel

Aggregate demand is defined as…


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demand for a country’s goods and services over a period of time.demand for a country’s goods and services over a period of time.

demand for a country’s goods and services over a period of time, at a given price level.

demand for a country’s goods and services over a period of time, at a given price level.

none of the above.none of the above.

demand for a country’s goods and services over a range of price levels, over a period of time.

demand for a country’s goods and services over a range of price levels, over a period of time.

Aggregate demand is the quantity of goods and services which consumers are willing and able to buy over a period of time and at a given price level. Hence, option B is the correct response.

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As a component of aggregate demand, investment is best defined as total expenditure in the economy by…


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businesses and government on all goods and services.businesses and government on all goods and services.

businesses on all goods and services minus exports.businesses on all goods and services minus exports.

businesses on all goods and services.businesses on all goods and services.

businesses on capital goods.businesses on capital goods.

Since aggregate demand comprises consumption + investment + government spending + exports – imports, investment must include all spending by businesses. This includes purchases of stocks as well as fixed capital investment. Hence, option D is the correct response.

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A fall in the level of investment will most likely be caused by…


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a fall in the exchange rate.a fall in the exchange rate.

a fall in company profits.a fall in company profits.

a fall in the current account deficit.a fall in the current account deficit.

a rise in consumption.a rise in consumption.

The level of investment in an economy will depend on the availability and price of capital funds. Hence, a fall in profits, the most attractive source of funds, is most likely to reduce investment overall. Additionally, a fall in profits will make investment less attractive. Thus, option B is the correct response.

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The level of saving in an economy is NOT directly determined by…


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the rate of inflation.the rate of inflation.

the age profile of the population.the age profile of the population.

changes in real national income.changes in real national income.

the level of government spending.the level of government spending.

The rate of saving can be affected by several factors, including options A, B, and D above. The level of government spending has no impact on saving. Hence, option C is the correct response.

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Which one of the following is a characteristic of consumption?


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It determines the level of exportsIt determines the level of exports

It is a component of aggregate supplyIt is a component of aggregate supply

Its most important determinant is disposable income Its most important determinant is disposable income

Its level is unrelated to the amount of wealthIts level is unrelated to the amount of wealth

The level of consumption is determined by wealth, but, most significantly, is determined by its positive relationship with the level of income available for spending. Hence, option D is the correct response.

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The level of investment is NOT determined by…


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the rate of inflation.the rate of inflation.

the amount of retained profit held by firms.the amount of retained profit held by firms.

the level of household saving.the level of household saving.

the rate of interest.the rate of interest.

The level of investment reflects the factors featured in options A, B, and C. Although saving (a leakage) may be channelled into bank lending to businesses for investment (an injection), these 2 variables are independently determined. Hence, option D is the correct response.

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If exports were to increase, but, over the same period, imports were to increase even more, an economist would expect the economy to settle at a new equilibrium where…


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the price level and real output were lower.the price level and real output were lower.

real output was higher and the price level was lower.real output was higher and the price level was lower.

the price level was higher and real output was lower.the price level was higher and real output was lower.

real output and the price level were higher.real output and the price level were higher.

The level of exports and imports both affect the level of aggregate demand. If exports were to rise but imports were to rise even more, aggregate demand would fall at all price levels – a shift to the left in the aggregate demand curve. As a result, the price level and real output would be lower at the new equilibrium. Hence, option A is the correct answer.

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The aggregate demand curve slopes downwards because at a higher price level…


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interest rates tend to be higher, and this in turn reduces demand and therefore the output of businesses making expensive goods.

interest rates tend to be higher, and this in turn reduces demand and therefore the output of businesses making expensive goods.

purchasing power is reduced and, therefore, less is bought and, therefore, made.purchasing power is reduced and, therefore, less is bought and, therefore, made.

all of the above.all of the above.

foreign goods and services will become relatively cheaper, and there is less demand for UK output.

foreign goods and services will become relatively cheaper, and there is less demand for UK output.

The reasons given in options A, B, and C are all valid, thus option D is the correct response.

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The impact of the multiplier will be smaller when…


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tax rates are higher.tax rates are higher.

there is a deflationary gap.there is a deflationary gap.

the economy is closed.the economy is closed.

interest rates are low.interest rates are low.

The impact of the multiplier depends on the extent to which there are leakages from the circular flow. When taxes are increased, leakage is greater and, therefore, the multiplier impact is reduced. Hence, option A is the correct response.

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Short-run aggregate supply is defined as the amount producers are willing to supply,…


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over a range of price levels, over a given period.over a range of price levels, over a given period.

at a given price, over a given period, assuming constant factor costs.

at a given price, over a given period, assuming constant factor costs.

assuming variable factor costs, over a given period, at a given price.

assuming variable factor costs, over a given period, at a given price.

at a given price, over a given period.

at a given price, over a given period.

Short-run aggregate supply is defined as the quantity that producers are willing to supply at a given price, over a given period, assuming constant factor costs. Hence, option B is the correct response.

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A short-run supply curve will NOT shift if…


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the productive capacity of the economy is reduced.the productive capacity of the economy is reduced.

factor costs remain unchanged.factor costs remain unchanged.

the price level increases. the price level increases.

interest rates fall.interest rates fall.

The short-run aggregate supply curve will not shift unless factor costs, such as wage costs change, or interest rates change. Hence, option B is the correct response.

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If a government were to increase factor mobility…


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the long-run aggregate supply curve would shift to the right.the long-run aggregate supply curve would shift to the right.

more would be produced at a higher price level.more would be produced at a higher price level.

the horizontal section of the aggregate supply curve would shift downwards.the horizontal section of the aggregate supply curve would shift downwards.

aggregate demand would shift to the right.aggregate demand would shift to the right.

By increasing factor mobility, factors are likely to be employed in more productive activity, attracted by higher income. This will result in higher real output in the long-run, which is represented by a rightward shift in long-run aggregate supply ie option A.

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Long-run aggregate supply will increase when there is…


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an increase in aggregate demand, and an increase in the labour force.

an increase in aggregate demand, and an increase in the labour force.

a change in real output, and an increase in the labour force. a change in real output, and an increase in the labour force.

a constant price level. a constant price level.

an improvement in technology, and a reduction in the labour force.an improvement in technology, and a reduction in the labour force.

Real output will only increase when both the potential for increased output is available (ie an increase in the labour force), but also when aggregate demand is sufficient. Hence, option A is the correct response.

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An increase in long-run aggregate supply depends on…


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an efficient banking system.an efficient banking system.

increases in aggregate demand.increases in aggregate demand.

emigration being greater than immigration.emigration being greater than immigration.

increasing employment.increasing employment.

An efficient banking system ensures that competitively priced investment funds are available to maintain and increase productive capacity. Hence, option A is the correct response.

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A fall in long-run aggregate supply can be caused by…


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an increase in the price level.an increase in the price level.

a slowdown in the rate of growth.a slowdown in the rate of growth.

all of the above.all of the above.

an increase in net emigration.an increase in net emigration.

A fall in long-run aggregate supply can occur if the quality or quantity of a country’s productive resources falls. Net emigration, where more people are leaving a country than are coming into it, means that the quantity of productive labour resources falls, and this will result in a leftward shift in the long-run aggregate supply curve. Hence, option C is the correct response.

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An increase in government spending on education will lead in the long-run to…


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an increase in aggregate demand , but no change to aggregate supply.an increase in aggregate demand , but no change to aggregate supply.

an unpredictable impact on aggregate demand, and an unpredictable impact on aggregate supply.

an unpredictable impact on aggregate demand, and an unpredictable impact on aggregate supply.

higher output but an unpredictable impact on the price level.higher output but an unpredictable impact on the price level.

a lower price level and an increase in aggregate demand.a lower price level and an increase in aggregate demand.

An increase in education spending will have an immediate impact on aggregate demand and lead to a higher price level, but a more educated workforce can be expected to be more productive and efficient, reducing short-run aggregate supply. This will allow long-run equilibrium to settle at a higher level of output. However, the impact on the price level cannot be predicted because it depends on the relative strength of the increase in aggregate demand, and the later reduction in short-run aggregate supply. Hence, option D is the correct response.

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Refer to the diagram below. An increase in aggregate demand from AD1 to AD2 will mean that…


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employment will increase, and aggregate supply will become more elastic.

employment will increase, and aggregate supply will become more elastic.

output, unemployment, and the price level will increase.

output, unemployment, and the price level will increase.

neither output nor employment can increase beyond Y2.

neither output nor employment can increase beyond Y2.

there will be an increase in the price level, employment, and real output.

there will be an increase in the price level, employment, and real output.

A shift in aggregate demand to AD2 means that this economy is in equilibrium at the point of full capacity. Output and, therefore, employment will have increased, as will the price level. Hence, option C is the correct response.

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PriceLevel

OReal OutputY2

LRASAD2

AD1

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