Workshop 17

(The Macroeconomic Environment)

The Macroeconomic Environment of Business

1. The following diagram shows an aggregate demand curve and an aggregate supply curve.
AS

AD

(a) Label the two axes.

(b) Give three reasons why the AD curve is downward sloping.

1. .............................................................................................................................................

2. .............................................................................................................................................

3. .............................................................................................................................................

(c) Why is the AS curve upward sloping (at least in the short run)?

................................................................................................................................................

(d) Give two things that could shift the AD curve to the right.

1. .............................................................................................................................................

2. .............................................................................................................................................

(e) Give two things that could shift the AS curve to the right.

1. .............................................................................................................................................

2. .............................................................................................................................................
2. The following table gives the aggregate demand and aggregate supply schedules in February 2013
for a particular country. (Ignore the AD2 and AS2 columns until question (d) below and AD3 until
question (h).)

Aggregate demand Aggregate supply

Price level AD2 AD3 AS2
(£ billions) (£ billions)

95 1000 _____ _____ 950 _____

100 970 _____ _____ 970 _____

105 950 _____ _____ 1000 _____

110 930 _____ _____ 1030 _____

115 915 _____ _____ 1060 _____

120 900 _____ _____ 1100 _____

(a) Draw the aggregate demand and aggregate supply curves on the following diagram, labelling
them AD1 and AS1.

125

120

115
Price level .

110

105

100

95

90
900 920 940 960 980 1000 1020 1040 1060 1080 1100
National income (£ billions)

(b) What is the equilibrium level of national income? ........................................................................

(c) What is the equilibrium price level? ..............................................................................................

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 Assume that over the next 12 months aggregate demand rises by £70 billion at all price levels
and that aggregate supply rises by £20 billion at all price levels.

(d) Enter the new figures for aggregate demand and aggregate supply on the table in the
columns AD2 and AS2.

(e) Draw the new aggregate demand and supply curves on the diagram, labelling them AD2 and
AS2.

(f) What is the new equilibrium level of national income in February 2014? .............................

(g) What is the rate of inflation in February 2014? ......................................................................

Assume that over the following 12 months aggregate demand rises by a further £50 billion at all
price levels but that there is no increase in aggregate supply beyond AS2.

(h) Enter the new figures for aggregate demand on the table in the column AD3.

(i) Draw the new aggregate demand curve on the diagram, labelling it AD3.

(j) What is the new equilibrium level of national income in February 2015? .............................

(k) What is the annual rate of inflation in February 2015? The formula is:
Inflation = ((Pt  Pt1) / Pt1)  100
where t is the year in question and t1 is the previous year....................................................

3. What would be the effect of each of the following events on actual and potential economic
growth? (Assume no other changes take place.)
(a) A reduction in the level of investment. Actual growth: rise / fall / no effect
Potential growth: rise / fall / no effect
(b) People save a larger proportion of their income. Actual growth: rise / fall / no effect
Potential growth: rise / fall / no effect
(c) A reduction in the working week. Actual growth: rise / fall / no effect
Potential growth: rise / fall / no effect
(d) Increased expenditure on education and training. Actual growth: rise / fall / no effect
Potential growth: rise / fall / no effect
(e) The discovery of new, more efficient techniques which could benefit industry generally.
Actual growth: rise / fall / no effect
Potential growth: rise / fall / no effect
(f) A reduction in interest rates. Actual growth: rise / fall / no effect
Potential growth: rise / fall / no effect

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4. The following diagram shows the aggregate demand and supply of labour and the total labour
force (N). Assume initially that there is no disequilibrium unemployment. Assume that there is a
contraction of aggregate demand and that, as a result, there is a recession. Assume also that
wage rates are ‘sticky’ downwards and as a result do not fall.

ASL
N

A
Real wage rate

ADL1
ADL2

O C D E F G
Number of workers

(a) What is the initial level of employment? .................................................................................

(b) What is the initial level of unemployment? .............................................................................

(c) What is the level of employment after the onset of recession? ................................................

(d) What is the total level of unemployment now? .......................................................................

(e) How much is equilibrium unemployment? ..............................................................................

(f) How much is disequilibrium unemployment? .........................................................................

(g) Assume now that wage rates are not sticky downwards and fall to the equilibrium. How
much is unemployment now?
...................................................................................................

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5. Given the following possible types of unemployment  demand-deficient, real-wage (wage
push), frictional, structural, regional, technological and seasonal  which one is likely to worsen
in each of the following cases? (There may be more than one case of a particular type.)

(a) The introduction of robots in manufacturing. .........................................................................

(b) The economy moves into recession. .......................................................................................

(c) Legislation is passed guaranteeing everyone a minimum

wage that is 80% of the national average. ...............................................................................
(d) The government decides to close job centres in an
attempt to save money. ...........................................................................................................

(e) The Bank of England raises interest rates. ..............................................................................

6. The following table shows the consumer prices index (CPI) for the UK, where 2005 = 100.
Calculate the rate of inflation for the ten years 1991–5 and 2008–12. The formula is:
Inflation = ((Pt  Pt1) / Pt1)  100
where t is the year in question and t1 is the previous year. Give your answer to one decimal
place.
(The figures for 1990 and 2007 are given and are based on indices of 66.77 for 1989 and 102.30
for 2006.)

Year 1990 1991 1992 1993 1994 2007 2008 2009 2010 2011

Price index (P) 71.44 76.80 80.10 82.10 83.74 104.65 108.42 110.81 114.46 119.61

Rate of inflation 7.0 2.3

7. Will the following lead to cost-push or demand-pull inflation, or both?

(a) The Bank of England cuts interest rates and the
economy booms. Cost-push / Demand-pull / Both
(b) As a result of falling unemployment, trade unions become
more militant and demand higher wages. Cost-push / Demand-pull / Both
(c) The government raises the rate of VAT. Cost-push / Demand-pull / Both
(d) The government cuts income tax rates and raises
government expenditure at a time of near full employment.
Cost-push / Demand-pull / Both
(e) Increasing industrial concentration leads to more
oligopolistic collusion to raise prices. Cost-push / Demand-pull / Both

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8. Position each of the following eight terms in the UK’s circular flow of income diagram below:
Consumption (of domestically produced goods and services); Net saving; Net taxation;
Government expenditure; Factor payments (national income); Expenditure on imports;
Investment; Expenditure on exports.
Economists use specific letters to label each of these terms. The letters used are:
S, G, X, M, I, Cd, T, Y
Attach the correct letter to each of the terms you have written on the diagram.

9. Which of the following are changes in injections into, and which are changes in withdrawals
from the UK’s circular flow of income? In each case, identify whether the change is an increase
or a decrease. In each case, assume that this is the only change. (Delete wrong words.)

(a) A council funds the building of new libraries. ...................................... Withdrawal/Injection

...................................................................................................................Increase/Decrease
(b) The government raises tax-free thresholds. .......................................... Withdrawal/Injection
...................................................................................................................Increase/Decrease
(c) The government reduces child benefit. ................................................. Withdrawal/Injection
...................................................................................................................Increase/Decrease
(d) Fewer tourists visit the UK. .................................................................. Withdrawal/Injection
...................................................................................................................Increase/Decrease
(e) Firms, anticipating a rise in consumer demand, borrow
more money in order to build up their stocks. ...................................... Withdrawal/Injection
...................................................................................................................Increase/Decrease
(f) Consumers demand more goods than are domestically produced
(but total consumption does not change). ............................................. Withdrawal/Injection
...................................................................................................................Increase/Decrease
(g) People invest more money in banks and
building societies. ................................................................................. Withdrawal/Injection
...................................................................................................................Increase/Decrease