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Explain the concept of potential output and why actual output can differ from potential output? (2 marks) Potential output is the amount of output that an economy can produce when using its resources such as capital and labour, at normal rates. Potential output is not a fixed number but grows over time, reflecting increases in both the amounts of available capital and labour and their productivity. As capital and labour can be utilised at greater than normal rates, at least for a time, a country's actual output can exceed its potential output. Identify two factors that might cause a change in the level of potential output. For each factor briefly explain why they can affect potential output. (2 marks) Unfavourable weather…show more content…
(Price level and the interest rate, are held constant). Increased saving, decreases consumption hence drops Y=PAE (C+I(p)) and increases withdrawals and hence saving curve increased. Equilibrium GDP would increase if there were an increase in exports (raises PAE, raising whole line therefore equilibrium point is higher) PAE=C+I(p) +G+X-M Explain what is meant by the multiplier? Why, in general, does a one dollar change in exogenous expenditure produce a larger change in short-run output? (4 marks) EXAMPLE The multiplier, otherwise known as the income-expenditure multiplier, is the effect of a one-unit increase in exogenous expenditure on short-run equilibrium output. The multiplier arises because a given initial change in spending changes the incomes of producers, which leads them to adjust their spending, changing the incomes and spending of other producers, and so on. Ultimately, these successive rounds of declines in spending and income may lead to a decrease in planned aggregate expenditure, and output that is significantly greater than the change in spending that started the process. Explain the role played by the marginal tax rate in determining the size of the multiplier. Other things equal, how does a cut in the marginal tax rate affect the size of the multiplier? (2 marks) PAGE 214 If the government sets a high tax rate, a change in domestic income

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