2015 (AD/AS) Paper 3 HL

2015 (AD/AS) Paper 3 HL

The full employment level of output for Country A is identified as $18 billion per year. A decrease in consumer expenditure has led to a decrease in aggregate demand of $9 billion.

 

(a)  (i) Identify two possible reasons for a decrease in consumer expenditures.

·      Taxes could have increased causing consumers to have less disposable income therefore reducing consumer spending.

·      Decrease in consumer confidence will decreases consumer spending.

·      Increases in interest rates cause consumers to curtail borrowing, including loans, credit cards, and investment.

·      High levels of household debt will cause consumers to buy less as their disposable income are used to service their debt.

·      A decrease in wealth (the stock market decreases) if people’s wealth falls people will feel poorer and therefore will spend less.

·      If the economy has become a recession people have lost their jobs and therefore consumer spending will fall.

 

(ii) On the diagram, draw and label the new aggregate demand curve following the decrease in consumer spending.

(iii) State the amount in billions by which the full employment level of output exceeds the short-run equilibrium level of output.

 

$18b – 14b = $4b

 

A reduction of 9b of consumer spending is a horizontal shifting left of the AD curve by 9b but the upward sloping SRAS curve coupled with the AD has equilibrium decreasing by 4b.

(iv) On the diagram, draw and label the long-run aggregate supply curve for Country A.

(v) Identify the Average Price Level and level of real output when Country A has returned to long run equilibrium as a result of the interaction of market forces.

 

Real output = $18b

APL = 75 (measured by the CPI)

Understand that if the economy is in a recession, in the long-run people will accept lower wages, input prices will fall, with lower input prices and wages businesses will lower their prices,

shifting the SRAS curve to the right,

The economy will return back to LR equilibrium (Output 18b) at a lower Price Level (75)

(b)  Explain, giving two reasons, why the aggregate demand curve has a negative slope.

 

Interest Rate Effect - If the APL increases, interest rates are likely to rise, discouraging investment and consumer spending.

 

Export Effect - If the APL increases, the economies exports become less competitive, reducing demand for exports.

 

Real Wealth Effect - If the APL increases, then real wealth decreases, so people will spend less. (Real income not acceptable)