1.

Using a circular flow model diagram, Identify four expenditure components of GDP and explain
each of these.
- Consumption Expenditures (C) refers to spending by individuals and households on
goods and services. It is the single largest component of national expenditure.
- Investment Expenditure (I) refers to spending by all firms within the economy in order
to increase their capital stock and production capacity.
- Government spending (G) refers to spending of the public sector.
- Net export expenditure (X-M) refers to the difference between the country's export
earning and its import expenditure in the year.

2. Using the circular flow model diagram explain why the three ways of measuring GDP give rise to
same result

1. The output method measures the actual value of all final goods and services produced
within the economy each year. This method is also referred to as national Output (O).

2. The income method measures economic activity by calculating the value of all factor
incomes earned in the economy, that is, it is the sum of wages and salaries, rent,
interest, and profits. This method is also referred to as national Income (Y).
 3. The expenditure method measures economic activity by calculating the value of total
spending on newly produced goods and services during the year, comprising
consumption (C), investment (I), government (G) and net exports (X-M).

3. Using a business cycle diagram, distinguish between short term fluctuations and long term growth
trends.
- Curve is short term and Dotted line is long term.

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4. Using a business cycle diagram, describe how the natural rate of unemployment relates to full
employment level of output and potential level of output.
5. Use business cycle diagram to describe three important macro economic objectives
6. Define aggregate demand and explain each of its four components
7. Show aggregate demand diagrammatically, explain the relationship it represents.
8.Define the AD, explain the reasons for negative slope of AD using diagram.
9.Explain the shifts in AD using diagrams.
10.Define the AS and explain the shifts in AS using diagrams.
11. If the U.S. dollar decreases in value relative to other currencies, how does this affect the aggregate
demand curve? Explain.
12. Suppose a developing country receives more machinery and capital equipment as foreign
entrepreneurs increase the amount of investment in the economy. As a result,

13. Hurricane Katrina destroyed oil and natural gas refining capacity in the Gulf of Mexico which
subsequently drove up natural gas, gasoline, and heating oil prices. Three years later, once the refining
capacity was restored, these prices came back down. The restoration of refining capacity should

14. Interest rates in the economy have fallen. How will this affect aggregate demand.
15. The invention of the cotton gin ushered in the Industrial Revolution and began a long period of
technological innovation. What did this technological change do the short-run supply curve?

1) Define aggregate demand and explain each of its four components.

- The value of all goods and services demanded in the economy per time period. It is
calculated as the total amount of spending in the economy, usually per year.

4 components of AD:
- Consumption Expenditures (C) refers to spending by individuals and households on
goods and services. It is the single largest component of national expenditure.
- Investment Expenditure (I) refers to spending by all firms within the economy in order
to increase their capital stock and production capacity.
- Government spending (G) refers to spending of the public sector.
- Net export expenditure (X-M) refers to the difference between the country's export
earning and its import expenditure in the year.

b) Show aggregate demand diagrammatically and define the relationship it represents.

Reasons for Downward slope:

Negative relationship between Price level and real GDP due to
➔ Interest rate effect- PL ↑ Borrowing and Interest ↑ GDP ↓
➔ Wealth effect- PL ↓, Value of wealth ↑,
GDP↑
➔ Exchange rate effect- PL ↑ Foreign demand ↓- ↓ GDP

2) Using diagrams, distinguish between a movement along the AD curve and a

shift of the AD curve, and provide examples of the causes of each.Identify the
four components of spending that cause shifts of the aggregate demand
curve.

3) Using diagrams, show the impact of each of the following on the aggregate
demand curve; explain what happens to aggregate demand in each case; and
identify the component(s) of aggregate expenditure involved.

A) Consumer confidence improves as consumers become optimistic about future

economic conditions.
B) The government decides to increase taxes on firms' profits.
C) Firms become fearful that a recession is about to begin.
D) The government decides to increase its spending on health care services.
E) There is a decline in the real estate market (average house prices fall).
 F) The central bank (a government organization) decides to increase interest rates.
G) There is an increase in the level of indebtedness of consumers and firms.
H) Real incomes in countries that purchase a large share of country A's exports fall;
examine the impact on aggregate demand in country A.
I) The government lowers personal income taxes (taxes on income of households).
J) New legislation makes property rights more secure.
K) There is an appreciation (an increase) in the value of the euro relative to the US
dollar; examine the impact on aggregate demand in euro zone countries (countries
that use the euro).
L) There is an appreciation (an increase) in the value of the euro relative to the US
dollar; examine the impact on aggregate demand in the United States.
M) A nongovernmental organization (NGO) introduces a programme providing credit to
small farmers, making it easier for small farmers to borrow to finance the building of
irrigation projects.

1) Define aggregate supply.

Total amount of goods and services that all industries in the economy will produce at a given
price level

B) Explain why the short-run aggregate supply curve is upward-sloping.

Reasons for Upward slope:
Positive relationship between Price Level and Real output is due to Firm profitability.
➔ Increase in Price Level
➔ Increase in Profit
➔ Incentive to increase Quantity of Output
➔ Thus Y increases when PL increases

2) Distinguish between the short run and the long run in macroeconomics.
Short Run: Government is unable to make changes to price level
Long Run: Government can make changes to price level

B) What are some of the factors that cause wages to be inflexible (not change very
easily and rapidly)?
The flexibility of wages depends on the relations of labour and organized business. If unions
are strong and powerful, wages are less likely to be flexible and wages could be maintained at
W2 – this would be an inflexible wage. Wages can be 'sticky' for numerous reasons including –
the role of trade unions, employment contracts, reluctance to accept nominal wage cuts and
'efficiency wage' theories.

3) Show the short-run aggregate supply (SRAS) curve in a diagram, and explain
what relationship it represents.
A) Identify the factors that can cause a movement along the SRAS curve.
B) Identify the factors that cause shifts in the SRAS curve.
4) Using diagrams, show the impact of each of the following on the SRAS curve;
explain what happens to SRAS in each case.
A) The price of oil (an important input in production) increases.
B) Below-zero temperatures destroy agricultural output.
C) The government lowers taxes on firms' profits
D) The government eliminates subsidies on agricultural products.
E) There is an increase in the minimum wage.

5) Using diagrams, show the effects of each of the following on short-run

equilibrium, explaining what happens to the equilibrium price level, output and
unemployment.

A) The price of oil (an important input in production) increases.

B) Firms are pessimistic about the future of the economy.
C) Below-zero temperatures destroy agricultural output.
D) The government lowers taxes on firms profits
E) There is a large rise in stock market
F) The government eliminates subsidies on agricultural products.
G) A war destroys a portion of an economy's physical capital.
H) Consumer confidence improves.