Evaluate using the multiplier, the likely effect on the UK price level an equilibrium real output of the changes referred to in the information provided.

This however, depends on the magnitude of the multiplier; in reality it may only be 1 or 2. Also, withdrawals in the economy must also be taken into account. As people purchase more, they will spend more money on imports and holidays and this will reduce how much consumption increases by and therefore AD will shift. Therefore the price level may only rise slightly more than the increase in real output.

Extract 1 explains that interest rates should be raised to combat the perturbing levels of debt accumulated by British households, and increase the amount paid back by the British household. Increased interest rates will mean borrowing money will become more expensive and saving money will become more attractive. Therefore both consumption and investment will decrease. Both these determinants are the largest components of AD therefore the demultiplier will potentially be very large. Divestment and decreased consumption will mean the AD curve will shift greatly to the left and carry on doing so due to demultiplying effects; because its demand deficit and consumer demand decreased and prices will fall and then it becomes less profitable to produce goods/services. Output will then fall, therefore the output curve will also shift to the left. The demultiplier effect will result in both the price level and GDP falling from P1 to P2 and Y1 to Y2.

 However the AS curve will shift to the left as output falls, and therefore GDP will fall again but now the price level will increase due to cost-push inflation. Nonetheless, the amount that the AD curve will shift depends upon the effect of a rise in interest rates will have on exports. A rise in interest rates should result in an appreciation of Sterling. Therefore the UK will begin to export more and import less and this will minimise the amount that AD shifts. This however, is likely to be insignificant as exports are only a small component of aggregate demand in the UK economy.

Extract 2 states that the UK could see growth in exports due to greater trade with newly expanding countries in Asia. Exports are injections so a positive multiplier effect will be observed, and in the short-run this will shift the AD curve to the right. The price level will rise in addition to a rise in GDP. Yet, when considering the classical LRAS curve may shift to the right in AD this can be devastating to the UK economy due to the perfectly inelastic nature of the curve, the price level will keep on rising without seeing a rise in GDP. This will result in a rise in inflation.

If UK exports were to rise considerably then this would make it a greater component of AD. Greater exports will be an injection into the economy. This will mean due to the multiplier that AD will keep on shifting to the right. Also, the trade deficit will be reduced. UK firms will see more demand, and it will become more profitable to export and therefore output will increase.

The AS curve will shift to the right which is good as GDP will rise but the price level will fall. However, this all depends upon the fact that the UK can take advantage of the increased growth in other countries. Competition is high, and the UK will find it hard to compete with other countries such as China due to wages being higher and increased regulation, all of which increase the costs of production. The UK therefore may struggle to export more especially if interest rates rise and investment decreases.