Question

1. What is the circular flow of income? What are the 4 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. Why does the short-run aggregate supply (SRAS) curve slope upward to the right? What

does the upward slope indicate?

4. What are the major factors that influence the quantity of goods & services a group of

people can produce in the long run? Why is the long run aggregate supply curve (LRAS)

vertical? What does the vertical nature of the curve indicate?

5. 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?

6. Why is an unanticipated increase in the price level likely to expand output in the short run,

but not in the long run?

Answer 1

1.

Circular flow of income refers to the model that depicts the movement of resources and income from one sector or market to another sector or market. In its most basic form, circular flow of income has two sectors or market. First is household and second is business. Households provides factors of production and create factors market. Second is business that builds products & services market. Here, households earn income by selling their labor in factor market and spend that income in products and services market. By this way, income circulates.

4 key markets are households (factor market), businesses (product & services market), government and exports.

2.

People in the economy buy more goods when prices are lower. As a result, aggregate demand increases with a decrease in price and vice versa. It makes aggregate demand to be inversely proportional to the price. It sets the inverse relationship between aggregate demand and price.

The inverse relationship shows that with rise in price, quantity demanded will decrease and vice versa. It makes policy makers to ensure that economy should have stable prices so that economy grows in real terms.

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