GDP=C+I+G+(X−M)

Choices A and D are incorrect because saving and taxes are never included in GDP. Choice B is incorrect because the equation calculates net exports incorrectly.

Explanation:
When AD decreases (AD to AD11), the economy will be producing below its full-employment level of output: this is known as a recessionary gap.

During a recessionary gap, unemployment rises as businesses lay off workers in response to decreasing aggregate demand.

Choice A would be correct if AD shifted rightward.

Choice C would be correct if SRAS shifted leftward.

Choice D is not possible, as rising unemployment is a defining characteristic of a recession.

Explanation:
Choice D is the correct answer because it shows that the equilibrium price level would increase without any increase in the equilibrium GDP level. This occurs when the economy has reached the full employment real GDP and there are no unused factors of production. Increasing AD causes inflation without any growth to real GDP.

Choice A is incorrect because it shows a scenario of growth without any inflation.
Both choices B and C depict a scenario of growth with inflation where both the equilibrium APL and real GDP increase.

Explanation:
A decrease in aggregate demand will create a recessionary gap and push the economy into recession. This creates cyclical unemployment, which is caused by a decrease in overall aggregate demand, and so businesses decrease their demand for labor.

Choices A, C, and D are also types of unemployment, but they are not caused by a decrease in aggregate demand.

Explanation:
A decrease in sales taxes will lower production costs for businesses across the economy, which increases short-run aggregate supply, reducing inflationary pressure.

Choice A will cause demand-pull inflation. Choices B and C will cause cost-push inflation. Therefore, choices A, B, and C are causes of inflation.

Explanation:
There is often a conflict between achieving economic growth and environmental sustainability. The pursuit of better economic well-being for citizens and increased efficiency of the economic system does not always guarantee environmental sustainability.

Economic growth is often accompanied by job creation and improvements in the standard of living of many citizens, so choices A and B are likely to be true. Economic growth often means an increase in total output produced by the economy, which involves the use of more resources and the production of more waste, so choice C is likely to be true.

It is least likely that economic growth is accompanied by decreases in greenhouse gas emissions, and thus choice D is the least likely to be true.

Explanation:
The goals of a central bank are focused on achieving short-term economic stability. These objectives include achieving low and stable inflation, implementing inflation targeting (choice A), reducing unemployment rates (choice B), and minimizing fluctuations in the business cycle (choice D).

Choice C is the correct answer because it is usually attributed to the goal of the executive branch of government and not the central bank.

Explanation:
There is often a conflict between achieving economic growth and equity in the distribution of income.

The pursuit of better economic well-being for citizens and increased efficiency of the economic system does not always guarantee an equitable distribution of the benefits.

Choices A and C are also possible conflicts with the goal of high economic growth, while choice B often accompanies high economic growth.

Explanation‾Explanation:
The unemployment rate is calculated using the following equation:

Number of unemployed/Size of labor force × 100

500 000/8 million × 100 = 6.25%

Choice B divides the number of unemployed by the working age population, rather than the size of the labor force.

Choice C adds discouraged workers to the number of unemployed.

Choice D adds discouraged workers and divides by population of working age.

Explanation:
Statement I is incorrect because an increase in interest rates will lead to higher borrowing costs and a higher reward for saving, resulting in decreased investment expenditure and consumption, thus decreasing AD, not SRAS.

Statement II is incorrect because lower consumer confidence will lead to lower consumption expenditure and decreased AD, not SRAS.

Statement III is correct because higher costs of production across the economy will shift the SRAS curve to the left.

Statement IV is correct because an increase in indirect taxes will also raise the costs of production for businesses and thus shift SRAS to the left.

Explanation:
Changes in taxation and government spending can be directed towards different socioeconomic groups or different branches of industry.

Choice B is wrong because there are many trade-offs in achieving macroeconomic goals. For example, increased economic growth and employment can cause high inflation and/or a current account deficit.

Choice C is wrong as it can take time:

• for governments to recognise that action is required in the first place
• for political bodies to agree on what to do
• for the policy to impact the economy

Choice D is wrong because expansionary fiscal policy will have a greater impact on real output if there is plenty of excess capacity in the economy.

Explanation:
In the Keynesian model, wages are assumed to be downwardly inflexible: they may rise in times of inflation, but rarely fall in times of recession. For this reason, the economy could get stuck in a recessionary gap if the government does not intervene. This is because production costs will not fall, and so, aggregate supply will not increase.

Choices A, B, and C are all associated with the new classical/monetarist model, which assumes that recessionary gaps are not persistent.

Explanation:
Choice D is the correct answer because if consumer confidence and business confidence are weak or pessimistic, they would have a dampening effect on the effectiveness of interest rate decreases. If so, consumption and investment spending will not increase as much as desired.

The following are strengths of monetary policy:

• Choice A gives the central bank flexibility in responding to changing economic conditions.
• Choice B allows the central bank to make more targeted changes to the economy.
• Choice C gives the central bank more freedom because it can reverse policies that do not achieve the desired effect.

Explanation:

Choice B

• If the ECB purchases government securities (bonds), it increases the money supply as it pays bondholders.
• If the ECB lowers the reserve requirement, commercial banks have more excess reserves for more loanable funds that increase credit creation and the money supply.
• If the ECB decreases the interest rate that it charges commercial banks (minimum lending rate or discount rate), banks borrow more and can lend more, increasing the money supply.

Choices A, C, and D include actions that decrease the money supply

• selling securities
• raising the reserve requirement
• increasing the minimum lending rate

Explanation:
Closing an inflationary gap requires a decrease in AD, and increasing income tax and reducing the money supply are both contractionary policies, making D the correct answer.

Choices A, B, and C include expansionary policies, which do not close inflationary gaps.

Explanation:
Current expenditure refers to government spending on goods and services within the year.

Choice A is wrong, as it is an example of capital expenditure—government spending to expand the economy's productive capacity.

Choices C and D are wrong, as they are examples of transfer payments.

Explanation:
Statements I and III are characteristics of interventionist supply-side policies. Providing education or improving quality and access to health care improves human capital, increasing aggregate supply.

Statement II is an example of a market-based supply-side policy aimed at encouraging competition, rather than a characteristic of interventionist supply-side policies

Statement IV is also characteristic of interventionist supply-side policy, because providing infrastructure makes the economy more efficient and productive.

Explanation:
Short-run equilibrium occurs at the intersection of AD and SRAS. Long-run equilibrium occurs when AD = SRAS = LRAS. Therefore, at point $A$, the economy is in short-run equilibrium only.

Explanation:
Governments borrow by issuing bonds, which domestic or overseas individuals or entities (such as commercial or central banks) can purchase.

Choice A is incorrect because transfer payments only entail a redistribution of income. They do not directly increase demand for a nation’s goods or services.

Choice B is incorrect, as contractionary fiscal policy lowers inflation, making exports more competitive. Additionally, contractionary fiscal policy suppresses consumer spending, including spending on imports.

Choice D is incorrect, as fiscal policy can redistribute income by adjusting income tax and transfer payment policies.

Explanation:
Statement I is correct because deregulation lowers production costs and makes it easier for new competitors to enter the market. These outcomes encourage competition.

Statement II is incorrect because personal income tax cuts fall under market-based supply-side policies relating to incentives, rather than encouraging competition.

Statement III is correct because removing barriers to trade will allow foreign businesses to compete with domestic businesses. This competition incentivises domestic firms to be more efficient.

Statement IV is incorrect because abolishing minimum wages falls under market-based supply-side policies that are aimed at making the labour market more flexible rather than policies to encourage competition.

Explanation:
LRAS shifts rightward when there is an increase in the quantity or quality of factors of production (FOPs), improvements in technology, increases in efficiency, or improvements in institutions.

Choices I and II: both will shift LRAS to the right. An increase in immigration increases the quantity of labour, and improvements in technology will increase efficiency in production, improving the quality of FOPs.

Choices III and IV are determinants of SRAS that would lower production costs and thus shift the SRAS curve rightward. Indirect taxes and production costs do not affect the quality or quantity of FOPs, so LRAS is unaffected.

Explanation:

The AS curve shifts when there are changes in the costs of factors of production or indirect taxes (VAT). The AD curve shifts when there is a change in domestic consumption, investment, government spending, or net exports.

A cut in income tax would increase AD (AD1 to AD2), increasing disposable income and domestic consumption. A rise in indirect taxes would decrease AS (AS1 to AS3), as it would increase production costs across the economy.

Explanation:

Leakages involve income earned that is not spent on domestic goods and services. Leakages include: saving, taxes, and import spending.

Export revenue is an injection into the circular flow, not a leakage.

Therefore, choices A, C, and D are incorrect because export revenue is an injection, not a leakage.

Explanation:
Statement I is incorrect. Discretionary spending refers to changes in spending that require a decision to be made by the government. Such changes are not automatic.

Statement II is correct. Progressive taxation and unemployment benefits act as automatic stabilisers. In countries with a more progressive income tax and a larger welfare state, the impact of automatic stabilisers will be more significant.

Statement III is correct. Automatic stabilisers make the business cycle less volatile, keeping the growth rate lower in $\text{‘}$boom$\text{’}$ periods.

Explanation:
Statement I is correct: an outward shift of the PPC illustrates long-term growth or growth in production possibilities.

Statement II is correct: a movement closer to an existing PPC shows short-term growth, or growth in actual output.

Statement III is correct: an outward shift of the PPC occurs if the quantity of resources increases.

Statement IV is incorrect: an increase in the quality of resources shifts the PPC outward.