AS Macro economics 18 markerWatch
I seem to be struggling, if anyone could give it a quick read and give some ideas on how to improve that would be highly appreciated
Edit the question is :Discuss how an increase in consumer spending may impact output and inflation (18 marks)
An increase in consumer spending will in theory increase the output of an economy and cause inflation. Consumer spending is defined as spending by households on consumer goods. Inflation is the sustained rise in price level whereas output is also referred to as real gdp which is an economy’s total output by price, so therefore is adjusted for inflation.
As consumer expenditure is a component of aggregate demand an increase in this will increase aggregate demand thus causing a shift of the curve to the right from AD to AD1. A shift in the aggregate demand curve represents a shift from Y to Y1 which is an increase in real GDP(output) as the macro equilibrium point has also shifted. Therefore an increase in consumption will give rise to an increase in output. The reasons for why consumption has increased maybe due a cut in income tax which would result into consumers being more willing and able to spend.
Aggregate supply does not shift the reason for this is because aggregate supply is only shifted if there is a change in the cost of production or the quantity/quality of the factors of production. As we move across the AS curve the factors of production are becoming more scarce due to the increase in consumption. This puts pressure on the current factors of production which results into some of the factors of production demanding for an increase in wage for example labour. To meet the demand of this there is an increase in price level from P to P1 also known as inflation. The main reason there is an increase in price level is because AS is not shifted so to meet the demand with the current supplies prices are increased.
However this depends upon the other components of aggregate demand .For instance investment is a component of AD and if this was to fall at a greater rate than the increase in consumption this would ultimately shift AD. For example, If consumption was to only go up by 50 units whereas investment was to fall by 100 it would be evident that AD would also fall The fall in investments due to possibly an increase in interest rates will mean the cost of borrowing will rise so the rate of return will be less. This will result into less investments thus shifting AD to the left from AD to AD1. If AS was exceeding AD due to the existence of unsold goods and services price level may fall.
Furthermore, the output and inflation rate could also depend on the exchange rates. A rise in a country’s exchange rates will reduce the price of imports as they will be relatively cheaper than before. It will also cause a rise in the price of exports. As a result of this the number of imports will be greater than the number of exports. This would mean we are in a current account deficit so the net exports would be negative . This results into a shift in AD to the left from AD to AD1 as both imports and exports are components of aggregate demand. Due to the shift in the AD curve this would also shift the point of macro equilibrium point and we will be going from a point of income of Y to Y1. This means there is a decrease in real GDP and price level may fall depending on the amount AD falls by.
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I think the big thing that is missing is a discussion on the shape of the AS curve and the current position of the economy i.e. if the economy is currently opperating on the far left of the diagram where the AS curve is almost horizontal, then you will see a large increase in output for a relatively small increase in inflaton, on the other hand if the economy is currently opperating on the far right of the diagram where the AS curve is almost vertical, you will see almost no increase in output but you will still get a jump in inflation. Therefore the most important factor in determining what the effect of an AD shift is, is where the economy is currently opperating.
Hope this helps