State three assumptions that underlie the aggregate demand and aggregate supply model.

That the whole economy's output can be represented by one measure of real output and all its prices by one general price level, that ceteris paribus holds so only the stated change occurs, and that the economy adjusts to the intersection of the curves.

Why is representing all prices by a single general price level a simplification?

Prices in different markets move at very different rates, so one index conceals large changes in relative prices that themselves alter behaviour.

Why is representing all output by a single real output figure a simplification?

Real output adds together very different goods and services, so the model says nothing about the composition or the quality of what is produced.

What role does the ceteris paribus assumption play in the model, and why is it a weakness?

It isolates the effect of one change by holding everything else constant, which is a weakness because in a real economy several variables usually move at once.

Why does the assumption that the economy moves quickly to equilibrium weaken the model?

Wages and prices are sticky, particularly downwards, so an economy can remain away from equilibrium with unemployed resources for a long period.

Define macroeconomic equilibrium.

Macroeconomic equilibrium is the combination of price level and real output at which aggregate demand equals aggregate supply, so there is no tendency for either to change.

OCR A-Level Economics H460

Introduction to Microeconomics

Topic overview Economic and free goods, scarcity and positive and normative statements Economic agents and the factors of production Factor rewards, rationality and the objectives of economic agents Incentives and the functions of the price mechanism Market, planned and mixed economies and allocative and productive efficiency Opportunity cost, trade-offs and the production possibility curve Shifts of the production possibility curve and uses of opportunity cost

Microeconomics: The Role of Markets

Topic overview Specialisation, the division of labour and barter Money as a medium of exchange and the gains from specialisation Individual and market demand and joint, competitive and composite demand Movements along and shifts of the demand curve Individual and market supply and joint and competitive supply Movements along and shifts of the supply curve Consumer surplus and producer surplus How changes in price affect consumer and producer surplus Ceteris paribus and market equilibrium and disequilibrium Changes in demand and supply and their effects on related markets Price and income elasticity of demand and total revenue Cross elasticity, price elasticity of supply and the uses of elasticity Marginal utility, marginal cost and decisions at the margin Market failure and marginal social cost and benefit Positive and negative production and consumption externalities Information failure, asymmetric information and merit and demerit goods Merit and demerit good diagrams and correcting information failure Public, private and quasi-public goods The free rider problem and the provision of public goods Indirect taxes and subsidies to correct market failure State provision, price controls, buffer stocks and legislation Regulation, tradable pollution permits and government failure

Microeconomics: Business Objectives

Topic overview Profit maximisation and alternative business objectives Corporate social responsibility and the principal-agent problem Fixed, variable, average and marginal costs Diminishing returns and economies and diseconomies of scale Total, average and marginal revenue Profit, loss and normal and supernormal profit

Microeconomics: Market Structures

Topic overview Perfect competition in the short and long run and allocative efficiency Productive efficiency and perfect competition as a benchmark Monopoly characteristics, equilibrium and static efficiency Dynamic efficiency, price discrimination and natural monopoly Characteristics of monopolistic competition and its short run equilibrium Long run equilibrium and efficiency in monopolistic competition Characteristics of oligopoly, concentration ratios and the kinked demand curve Non-price competition, collusion and the pros and cons of oligopoly Characteristics of contestable markets, sunk costs and hit-and-run entry Efficiency, barriers and the limits of contestable markets

Microeconomics: The Labour Market

Topic overview Derived demand for labour and wage elasticity of demand Labour productivity, unit labour costs and marginal revenue product Supply of labour and wage elasticity of supply Short and long run labour supply, transfer earnings and economic rent Wage differentials, labour mobility and monopsony Trade unions, bilateral monopoly and the effects of monopsony Wage determination in a competitive labour market and labour market flexibility

Macroeconomics: Aggregate Demand and Aggregate Supply

Topic overview The circular flow of income, injections and leakages Methods of measuring national income Components of aggregate demand and their determinants The slope of the aggregate demand curve and what shifts it Consumption, income and the role of expectations Short run and long run aggregate supply curves Shifts in short run and long run aggregate supply Macroeconomic equilibrium and the effects of demand and supply shifts The national income multiplier and marginal propensities The accelerator, the economic cycle and output gaps

Macroeconomics: Economic Policy Objectives

Topic overview Economic growth, real and nominal GDP and GDP per capita Short and long run growth, the economic cycle and the effects of growth Economic structure, deindustrialisation and sustainable development Limitations of GDP and the Human Development Index Employment, unemployment rates and the objective of full employment Measures, types and costs of unemployment and the effects of full employment Inflation, deflation, real values and the CPI and RPI Calculating inflation with index numbers and its causes and consequences Balance of payments accounts and current account calculations Causes and consequences of current account imbalances Key trends in UK macroeconomic performance Comparing UK performance internationally and the limits of economic data Income and wealth, redistribution and absolute and relative poverty Lorenz curves, the Gini coefficient and the causes of poverty The natural rate of unemployment and Keynesian and neo-classical aggregate supply Short and long run Phillips Curves and their usefulness

Macroeconomics: Implementing Policy

Topic overview The government budget, types of tax and the budget balance National debt, cyclical and structural deficits and crowding out The Laffer curve, average and marginal tax rates and limits of fiscal policy Interest rates, the money supply and inflation targets Quantitative easing, the exchange rate and limits of monetary policy Privatisation, deregulation and subsidies as supply side policies Competition policy, infrastructure, education and tax and benefit reform Labour market flexibility, immigration control and limits of supply side policy Conflicts between macroeconomic policy objectives

Macroeconomics: The Global Context

Topic overview Patterns of international trade and global supply chains Advantages and disadvantages of international trade Exchange rate calculations and how exchange rates are determined Exchange rate changes, the Marshall-Lerner condition and exchange rate systems Globalisation, international competitiveness and comparative advantage Terms of trade and the impact of globalisation and emerging economies Protectionism and the effects of a tariff Quotas, trade creation, economic integration and the World Trade Organisation

Macroeconomics: The Financial Sector

Topic overview Functions of money, credit creation and narrow and broad money The quantity theory of money and interest rates in the money market Roles of the financial sector, saving and investment The Harrod-Domar model and microfinance Financial regulation and the functions of a central bank Monetary policy effectiveness, limits of regulation and the IMF

Quantitative Skills for Economics

Topic overview Ratios, percentages, averages, graphs, index numbers and real values Cost, revenue, profit and elasticity calculations

Themes in Economics: Synoptic Application

Topic overview Choosing models and judging data and assumptions in an unseen theme Efficiency, equity, sustainability and ethics in economic judgements

Macroeconomics: Aggregate Demand and Aggregate Supply

Macroeconomic equilibrium and the effects of demand and supply shifts

3 things to know
Component 02

Overview

Recall questions on the assumptions of the aggregate demand and aggregate supply model, short and long run macroeconomic equilibrium, demand-pull and cost-push pressure, and the model's limitations.

What you need to know

Answer each one before you reveal it.

Your recallNot started

Key term

Long run aggregate supply shifts right. Describe the effect on growth and on inflation.

Key term

Why does a demand-led boom usually worsen the current account?

Key term

Distinguish demand-pull from cost-push pressure on the price level using this model.

Questions from this subtopic

Each one with the model answer underneath.

1
State three assumptions that underlie the aggregate demand and aggregate supply model.
Model answer
That the whole economy's output can be represented by one measure of real output and all its prices by one general price level, that ceteris paribus holds so only the stated change occurs, and that the economy adjusts to the intersection of the curves.
2
Why is representing all prices by a single general price level a simplification?
Model answer
Prices in different markets move at very different rates, so one index conceals large changes in relative prices that themselves alter behaviour.
3
Why is representing all output by a single real output figure a simplification?
Model answer
Real output adds together very different goods and services, so the model says nothing about the composition or the quality of what is produced.
4
What role does the ceteris paribus assumption play in the model, and why is it a weakness?
Model answer
It isolates the effect of one change by holding everything else constant, which is a weakness because in a real economy several variables usually move at once.
5
Why does the assumption that the economy moves quickly to equilibrium weaken the model?
Model answer
Wages and prices are sticky, particularly downwards, so an economy can remain away from equilibrium with unemployed resources for a long period.
6
Define macroeconomic equilibrium.
Model answer
Macroeconomic equilibrium is the combination of price level and real output at which aggregate demand equals aggregate supply, so there is no tendency for either to change.

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Introduction to Microeconomics

Microeconomics: The Role of Markets

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Microeconomics: Market Structures

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