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National Economy

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Economics

Economics has a long history of many differing theories and ideas. These economic theories and studies have influenced the economies of many different countries. This explanation of the national economy will take a trip down the history of economics to explain the national economy. Interested? Follow along!

National Economy: Meaning and Functions

The national economy in a global context is primarily about macroeconomics. But microeconomic principles do influence the behaviour of the macroeconomy.

A national economy is the production, distribution and trade, consumption of goods and services by different agents of a nation.

The main functions of a national economy are related to the production and consumption of goods and services. A national economy has goals and characteristics that allow it to function properly. However, these may be different from nation to nation. Let’s look at some of these goals and the general characteristics of a national economy.


Goals and Characteristics of a National Economy

Every country wants its economy to be successful. Thus, each nation has different goals that will ensure the success and stability of its national economy. Some goals an economy might have are:

  • Efficiency.
  • Equity.
  • Economic freedom.
  • Economic growth.
  • Full employment.
  • Price stability

You can learn more about these goals in more detail by checking out these articles: Economic Growth, Inflation and Deflation, and Unemployment.

In addition to goals, every economy has its own distinguishing features and characteristics.

The US economy is known for being the largest economy in the world and for having an advanced technological services sector that plays a very important role. The UK’s economy is known for its diversity: financial services, construction, tourism, etc., all play a part in the UK’s economy. The Japanese economy is known for its manufacturing sector: it's often viewed as an economy that is ‘well into the future’.

These distinguishing features could be based on the natural resources a country might have in abundance, like diamonds or gold. They could be based on what a country trades with other countries. They could also be based on the quality of their education systems or financial systems. Whatever it might be, each economy will have different characteristics.

However, there are a few characteristics most national economies might have in common. Some of these include:

  • Open economy. This relates to an economy that is open to selling and buying goods and services in global markets. Essentially, the economy is open to free trade.

Most countries have an open economy. Examples are the US, UK, France, Spain, and Norway.

  • Closed economy. This relates to an economy that is not open to selling and buying goods and services in global markets. They do not trade with any outside economy.

Not many countries are closed economies because raw materials like oil play a huge role in the global economy. However, there are a few countries like North Korea that trade very little with other countries. This is mainly due to the numerous sanctions imposed on this country.

  • Free market economy. This refers to an economy where the prices and distribution of goods and services are determined by supply and demand with little government intervention.

New Zealand, Singapore, and the US are examples of countries with a free market economy.

  • Command economy. This refers to an economy where the allocation of goods and services, the rule of law, and all economic activity is controlled by the government.

The economies of North Korea and the former Soviet Union are examples of a command economy.

  • Mixed economy. This is an economy that mixes both free-market and command economy characteristics. It combines both aspects of capitalism and socialism.

Germany, Iceland, Sweden, and France are a few examples of countries with mixed economies.

History of the Modern Economy: Theories and Developments

How did each of the countries in our previous examples decide to shape their national economy? Let's take a blast to the past!

National economies before the eighteenth century weren’t classified and differentiated like we do today. Each country had their own system and methods of trade and other financial transfers. It wasn’t until the mid-eighteenth century that the father of economics, Adam Smith, expanded on the studies of French physiocrats, notably Quesnay and Mirabeau, to argue for the free market economy.

In his famous book, The Wealth of Nations (1776), he argued that the invisible hand would create social and economic prosperity for all if there was little government interference.

National Economy Adam Smith was fundamental in the development of national economies StudySmarterFigure 1. Portrait of Adam Smith, the Father of Economics.Source: Scottish National Gallery, Wikimedia Commons.

Keynesian Era

Adam Smith's theories were dominant in economics for a long time, but they also had many critics. One of these critics was John Maynard Keynes.

John Maynard Keynes was a British economist. He believed that free-market capitalism is unstable and strongly supported government intervention. He believed that the government is in a better position to bring about good economic performance than the market forces.

In his book, The General Theory of Employment, Interest, and Money (1936), Keynes argued that by influencing aggregate demand by means of government policies, the UK could achieve full employment alongside optimal economic performance.

He proposed these ideas during the Great Depression and he was met with criticism from the British government. At the time, the British economy was experiencing a period of serious economic downturn. The government had increased welfare spending but had also raised taxes.

National Economy Keynes’ theories have been fundamental for many national economies StudySmarterFigure 2. Picture of Kaynes in 1933, Wikimedia Commons.

Keynes argued that this wouldn’t encourage consumption. Rather, he argued that if the government were to stimulate the economy, they needed to increase government spending and cut taxes, as this would lead to an increase in consumer demand and the overall economic activity in Britain.

However, by the end of the 1940s, Keynesian economics became more popular and soon many nations adopted his ideology. The only significant parts of the world that had rejected Keynesian principles were the communist nations. Economic historians label the years from about 1951 to 1973 as the 'Age of Keynes'.

The Free-Market Revolution

Keynes' beliefs were later met with disagreements from some other economists, namely Fredrick von Hayek and Milton Friedman.

Hayek was a firm believer in the free market and didn’t like socialism. His arguments were based on economic foundations, but he also used politics and ethics. For example, in his book The Constitution of Liberty (1960), Hayek argued that a free market system - that is protected with strong constitutions and laws, and well-defined and enforced property rights,- will allow individuals to pursue their own values and make the best use of their knowledge.

Milton Friedman started his campaign against Keynesian theories in 1957 with his book A Theory of the Consumption Function. Keynes’ model supported short-term solutions, like tax breaks, to increase consumer spending. His idea was that the government can increase economic activity without trading off future tax revenues - essentially, the government was able to have its cake (high economic growth and activity) and eat it (maintain tax revenues).

However, Friedman showed that individuals change their spending habits when real changes occur rather than temporary ones. Therefore, individuals and families would respond to changes like an income rise rather than a short term, temporary change like a stimulus check or a tax break.

Friedman wasn’t just an economist, but also a statistician. His arguments often were based on analysing empirical data and evidence, something Keynes rarely did. Because of that, Friedman could show the holes in Keynes’ frameworks and assumptions with data.

National Economy Milton Friedman: another important figure for national economies today StudySmarterFigure 3. Milton Friedman, Wikimedia Commons.

Friedman’s economic theories, beliefs, and views were in direct opposition to Keynes’. They started another branch of economics: monetarist economics.

The key difference between these theories is that monetarist economics involves the control of money in the economy, while Keynesian economics involves government spending. Monetarists believe that if the supply of money flowing into an economy is controlled, then the rest of the market can fix itself.

Monetary economics studies the different theories of money and examines the effects of monetary systems and policies. You can learn more about this in our Money Market and Monetary Policy articles.

Supply-Side Economics

The debate between no government intervention and government intervention would continue throughout the years. By the time Ronald Reagan became president of the US in 1981, a new form of economics had arisen: supply-side economics.

Supply-side economics, also known as Reaganomics, is the economic theory that suggests that tax cuts for the wealthy would result in increased savings and investment capacity for them that trickle down to the overall economy.

The idea is that tax cuts for wealthy investors, entrepreneurs, etc. will provide them with a greater incentive to save and invest. Their investments will then ‘trickle down’ to the wider national economy and produce economic benefits for all. Reagan often said ‘a rising tide lifts all boats’ to explain this theory.

What to learn more about supply-side economics? StudySmarter has got you covered! Check out our Supply-Side Policies explanation.

Present-Day Economics

Today, there are many branches and competing views of economics: behavioural economics, neoclassical economics, Keynesian economics, Monetary economics, and the list goes on.

Nation economies today, though don't need economic theories to account for resources, the allocation of goods, and services, for example, because they are already being accounted for in economic systems. Economic theory today is also much more mathematical and contains a lot of statistics and computational modelling than ever before.

Structure of a National Economy

StudySmarter has many explanations that will help you learn more about the national economy whether it's for personal interest or for your exams. Let's take a sneak peek at what you can expect.

Aggregate Demand

Aggregate demand is one fundamental concept in macroeconomics. It is essential for any economy. In our Aggregate Demand explanation, you will learn what it is and its components.

Aggregate Demand Curve

Our Aggregate Demand Curve will take your understanding of aggregate demand one step further. You will see how aggregate demand can be shown graphically and what factors will cause a movement along the curve or a shift of the curve. You will also learn two important concepts: the multiplier effect and the accelerator theory.

Aggregate Supply

Aggregate supply is linked closely to aggregate demand. It is also another fundamental concept in macroeconomics. You will understand the difference between the short-run and long-run aggregate supply curves, how to draw them, and the factors that determine aggregate supply.

Macroeconomic Equilibrium

Our explanation of Macroeconomic Equilibrium will take what you have learned about aggregate demand and aggregate supply, and combine them.

Circular Flow of Income

Our Circular Flow of Income explanation will take a look at open and closed economies in more detail. You will look at four circular flow models in depth and at the end, you will be able to determine what model describes your country's economy best.

National Economy - Key Takeaways

  • The national economy refers to the production, distribution and trade, consumption of goods and services by different agents of a nation.
  • Every country wants its economy to be successful, so each nation would have different goals that will ensure the success and stability of its national economy.
  • Every economy has its own distinguishing features and characteristics.
  • Adam Smith is known as the father of economics. He believed that the invisible hand would create social and economic prosperity for all if there was little government interference.
  • John Maynard Keynes was a British economist, who believed that free-market capitalism is unstable and strongly supported government intervention.
  • Fredrick von Hayek and Milton Friedman opposed Keynesian economics and based their arguments on empirical data and evidence.

National Economy

The national economy refers to the production, distribution and trade, consumption of goods and services by different agents of a nation.

Each economy has four main objectives:

  1. Economic growth.
  2. Low and stable inflation.
  3. Low unemployment.
  4. Balanced balance of payments.


Other objectives a national economy might have are:

  • Efficiency
  • Equity
  • Economic freedom.

The national economy is important because it gives economists, governments and individuals a gauge of each nation’s economic development. Understanding the national economy can help a nation when they experience an economic crisis/downturn and make the necessary adjustments to stimulate economic growth and economic activity.

There are many factors that affect a nation's economy. Some of these factors include:


  • Human resources

  • Physical capital

  • Natural resources

  • Technology

  • Education

  • Infrastructure

  • Level of investment

The major elements of the national economy are: 

  • Territory/region

  • Population

  • Natural resources

Final National Economy Quiz

Question

What is aggregate supply?

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Answer

Aggregate supply (AS) is a measure of the total volume of goods and services produced in the economy over a given time period.

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Name two types of aggregate supply.

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Answer

Short-run and Long-run

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What remains constant in the movement along the aggregate supply curve?

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Answer

Other factors

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What changes in the shift of the aggregate supply curve?

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Answer

Other factors

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Question

Which is the vertical aggregate supply curve?

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Answer

The long-run aggregate supply curve

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Who suggested the other concept of LRAS?

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Answer

Keynesians.

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When does macroeconomic equilibrium occur?

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Macroeconomic equilibrium occurs when aggregate demand meets aggregate supply.

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Question

How can we determine the output gap?

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The output gap is the difference between the actual output and the potential or trend output.

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What are the types of the output gap?

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  1. Positive output gap
  2. Negative output gap

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What is a positive output gap?

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A positive output gap occurs when the actual output is above the potential or trend output.

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What is a negative output gap?


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A negative output gap occurs when the actual output is below the potential or trend output.

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Question

What is aggregate demand?

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Answer

Aggregate demand (AD) is the total planned spending on the goods and services produced in the economy in a particular period. Aggregate demand measures how much are consumers, businesses, the government, people, and firms spending on goods and services.  

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What is the equation of aggregate demand?

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Answer

AD=C+I+G+(X-M)

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Question

What is the difference between savings and consumption?

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Answer

Consumption is the total amount of planned spending by households on goods and services that are produced in the economy. 


Saving happen when people decide to postpone their consumption until a future time. Saving can be referred to as disposable income that is not spent. 


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Question

What is the definition of Investment in the context of aggregate demand?

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Answer

 Investment is essentially planned demand for capital goods needed for the production of other goods and services.

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Question

What are the factors that influence investment decisions?

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  • Expected future sales revenue attributed to the new machinery.
  • Expected costs of production from the machinery as well as interest payments made from the borrowing to fund the machinery in the first place.
  • Maintenance costs of the machinery.
  • Expected future profit that is expected to be yielded from the machinery. 
  • Price of labour
  • Price of capital.
  • Technological development. 

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What is the accelerator effect?

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The accelerator effect is the relationship between planned capital investment and the rate of change in national income or aggregate demand.

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What are the three forms of government spending?

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  • Welfare spending, otherwise known as transfer payments. As an example, we can look at the welfare offered by various European countries such as social welfare services. 
  • Recurring spending, otherwise known as public services such as police, fire brigade, state education, National health services, local authority services. 
  • State investments (otherwise known as capital investments). This is spending on infrastructure, it is spending on capital goods needed to provide public services. These include roads and public buildings.


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What is the difference between current spending and capital spending?

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Current spending is the government spending on providing public services. 

Capital spending is the government spending on new public infrastructure.

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What is the definition of net exports?

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The net exports of a country, otherwise known as net trade balance, is the difference between the value of exports and imports(X-M).

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What are the factors influencing net exports?

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  • Relative prices of exports in the world markets.
  • Strength of aggregate demand in key export markets.
  • The exchange rate.
  • Non-rice demand factors.

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What are the components of AD that enable economic growth?`

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  • Consumption
  • Investment
  • Government spending
  • Net exports

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Question

What happens to the aggregate demand curve when there is a fall in price?

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Answer

 A fall in general price levels will lead to an expansion of aggregate demand.

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What happens to the aggregate demand curve when there is a rise in price?

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A rise in general price levels will lead to a contraction of aggregate demand. 

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When can aggregate demand change?

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Aggregate demand can only ever change if consumption of households, investments of firms, spendings by the governments, or spendings on net exports increase or decrease.

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What are the three effects called that make the AD curve downward sloping?


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-The wealth effect.

-The interest effect.

-The trade effect.

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When is there a shift in the aggregate demand curve?

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When the components of the AD curve change for reasons independent of price. 

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What is the circular flow of income?

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The circular flow of income, also known as circular flow, is an economic model in which necessary trades are represented as money, products, and services flows between economic players.

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The businesses and the individuals are the two groups that interact in the diagram.

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True

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In the circular flow graphic, individuals both receive and spend money.

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True

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Firms will pay all the money they acquire from the goods and services they sell to households for their factors of production in the simple circular flow diagram. 


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True

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What are the factors of production that individuals provide for businesses?


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Land

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Who provides factors of production for whom in the basic circular flow model?

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Businesses provide factors of production for individuals.

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Who buys products and services from whom in the basic circular flow model?

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Individuals buy products and services from businesses.

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What are the key features of the circular flow?

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Individuals

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How are injections in the circular flow model created?

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Injections are created when individuals and businesses borrow capital.

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What term is defined as a withdrawal in the flow?

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Leakage.

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What makes up the overseas sector?

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The import and export of commodities and services.

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What are the types of circular flow?


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Real flow and money flow are the types of circular flow.

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Taxes are the means through which money flows from individuals and businesses to the government. 


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True

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What is macroeconomic equilibrium?

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Macroeconomic equilibrium occurs at the point where the aggregate demand meets the aggregate supply.

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Macroeconomics equilibrium is the same in the short run and the long run.

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False

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How can we determine the macroeconomic equilibrium?

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Answer

The macroeconomic equilibrium occurs at the point where aggregate demand meets aggregate supply.

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Question

State some factors that may shift the AD and AS curves.

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Answer

  • Government policy

  • Available resources

  • Inflation or deflation

  • Tax 

  • Wages.

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Question

Explain the negative demand shock.

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Answer

A negative demand shock is when the aggregate demand reduces due to reduced spending, lesser stock, etc. and the AD curve shifts to the left reducing the price and output.

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Explain the positive demand shock.

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A positive demand shock is when the aggregate demand increases due to increased spending, higher stock, better output, etc. and the AD Curve shifts to the right increasing the price level and output.

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What is a positive supply shock?

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A positive supply shock occurs when the aggregate quantity supplied increases in the short-run due to the reduction in production cost or increased labour, technology advancement which results in the AS to shift in the right.

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What is a negative supply shock?

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A negative supply shock is when the aggregate supply reduces over the short run and the SRAS curve shifts to the left leading to an increase in price level and a decrease in the supply in the economy.

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Question

Explain the macroeconomic equilibrium equation.

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Answer

Y = Aggregate income = Macroeconomics equilibrium

C = consumption

I = Investment

G = Government expenditure

 

Therefore, the equation will be 

Y = C+I+G

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Question

Name the three types of macroeconomic equilibrium.

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Answer

  • The full employment equilibrium
  • The recessionary gap
  • The inflationary gap

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