Question

1.What is the circular flow of income? What are the four key markets of the circular flow model?

2. Why is the aggregate demand curve for goods & services inversely related to the price level? What does this inverse relationship indicate?

3. What are the major factors that influence the quantity of goods & services a group of people can produce in the long run?

4. Why is the long run aggregate supply curve (LRAS) vertical? What does the vertical nature of the curve indicate?

5. Why does the short run aggregate supply (SRAS) curve slope upward to the right? What does the upward slope indicate?

6. If the prices of both (a) resources and (b) goods and services increase proportionally will business firms have a greater incentive to expand output? Why or why not?

7. If the price level in the current period is higher than what buyers and sellers anticipated, what will tend to happen to real wages and the level of employment? How will the profit margins of business firms be affected? How will the actual rate of unemployment compare with the natural rate of unemployment? Will the current rate of output be sustainable in the future?

8. Why is an unanticipated increase in the price level likely to expand output in the short run, but not in the long run?

9. if the inflation rate increases and the higher rate is sustained over an extended period of time, what will happen to the nominal interest rate? What will happen to the real interest rate?

10. “When the U.S. dollar appreciates against the Euro, fewer dollars will be required to purchase a Euro.” Is this true? If the dollar appreciates, how will this affect net exports?

11. Can output rates beyond the economy’s long run potential be achieved? Can they be sustained? Why or why not?

12. When the economy is in long-run equilibrium, which of the following will be true?

a. The actual price level will be equal to the price level anticipated by decision makers.

b. The actual unemployment rate will be equal to the natural rate of unemployment.

13. (a) What is the difference between the real interest rate and the money interest rate?

(b) Suppose that you purchased a $5,000 bond that pays 7% interest annually and matures in five years. If the inflation rate in recent years has been steady at 3% annually, what is the estimated real rate of interest? If the inflation rate during the next five years rises to 8%, what real rate of return will you earn?

14. How is a nation’s trade balance related to its net inflow of foreign capital? If the inflow of foreign capital is used to finance the federal deficit, how will the well-being of future generations be affected?

Answer 1

1. Circular flow of income is an economic model which demonstrates how income circulates from one person to other in an economy. According to this model the flow of income is circular i.e. it ends on the person where it starts.

The four markets of the circular flow of income model are-

1. Households
2. Factor market
3. Firms
4. Goods and service market

The circular flow starts from households who provides factors of production (labour) to the Factor market and earn wages, Now factor market provides these factors to the firms where output is produced and then these output are taken to the product market and these output (goods and services) are bought by the households.

2.The aggregate demand curve for goods and services is inversely related to the price level this is also the key outcome of the law of demand. This is because as the price of goods and services increase then there is corresponding decline in the aggregate demand for goods and services and vice-versa. This inverse relation is mainly because when the price of goods and services increase but the income of the consumers remains the same then they can buy one less of these goods and services than before.

3.The major factors that influence the quantity of goods and services a group of persons can produce in the long run are -

• Availability of raw materials
• Availability of labour
• Availability of other factors of production.
• Existence of demand for that commodity.
• Attainment of level of technology.

If the factors of production exist and there is demand for the commodity then only the production of that commodity will take place in long run.

4. The long run aggregate supply curve is vertical because in long run the production of goods is not related to level of price but in long run there is limit up to where the supply of factors of production is possible. This point is called the point of full employment where all the factors of production is fully employed and hence output level can't be increased beyond it and hence the Aggregate Supply curve becomes Vertical.

The vertical nature of curve indicates that the output level can't be increased beyond that limit, and hence supply is fixed at that level and can't be increased.