Paper 2 - M 07 P2 4. Macroeconomic equilibrium does not...

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M07 P2 4. “Macroeconomic equilibrium does not necessarily occur at full employment.” Explain this statement using the concepts of inflationary and deflationary gaps. - definition of macro-equilibrium: when quantity of real GDP demanded equals the quantity of real GDP supplied - full employment macro-equilibrium: where SRAS intersects AD on the LRAS curve. Diagrammatic representation - deflationary or recessionary or under full employment gap, where planned expenditure is less than the full employment level of income. Occurs where AD intersects the SRAS curve at a level of real GDP that is below LRAS - inflationary or over full employment gap, where planned expenditure is greater than the full employment level of income. Occurs where AD intersects the SRAS at a level of real GDP that is above LRAS - some students may use the Keynesian Cross 45 degree model in place of the AD/AS model. Where this is appropriately done it should be fully rewarded 6. Using the principle of comparative advantage, explain why economic theory suggests that countries should specialize and trade with each other. - countries have different endowments of resources - absolute and comparative advantage, with examples - comparative advantage and opportunity cost - diagram and/or numerical example - specialization, trade and economic growth - constraints on trade distort optimal outputs and limit growth and development N06 P2 3. Explain how an increase in government spending can lead to crowding out. [10] • increase in government spending may involve an increase in the demand for loanable funds/money • higher interest rates raise the cost of borrowing to firms and therefore investment is likely to fall • governments use of loanable funds means that there is less available for private investment (notion of crowding out) • a diagram showing the demand and supply for loanable funds (money) may be used together win an investment diagram
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• a diagram showing AD/AS, with AD shifting to the right (due to an increase in government spending) and then to the left (due to a fall in investment) may be an
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This note was uploaded on 02/12/2010 for the course ECON 201 taught by Professor Smith during the Spring '10 term at Whittier.

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Paper 2 - M 07 P2 4. Macroeconomic equilibrium does not...

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