10.3 The Determinants Of Aggregate Demand Flashcards
What are the four determinants of AD
Consumption
Investment
Gov spending
Net export demand
What is aggregate consumption?
Total spending of all households
What is a determinate of consumption?
Household saving
What is the rate of interest?
The reward for lending savings to someone (bank) or cost of borrowing
What are the determinants of income(8)
Interest rates
Level of income
Expected future income
Wealth
Consumer confidence
The availability of credit
Distribution of income
Expectation or future inflation
What is Keynesian theory of consumption and saving
As income rises though absolute consumption rises consumption falls as a fraction of total income
(Cause of recessions too much saving and too little spending)
What is the life-cycle theory of consumption?
A theory that explains how consumption and saving in terms of how people expect their income to change over the whole of their life cycles
How can wealth a determinant of income or consumption?
Wealth increases saving for them so they don’t have to save, more money available for consumption
What is the availability of credit ?
Funds available for households and firms to borrow
What is the state of consumer confidence linked to?
People’s views on expected income and changes with personal wealth
Consumer optimism increases-households spend more and save less
What is credit crunch
Occurs when there is a lack of funds available in the credit market, making it difficult for borrowers to obtain financing, and leads to a rise in the cost of borrowing
What happens to consumption if credit is an available cheaply and easily ?
Consumption increases as people supplement current income by borrowing
What is the distribution of income .
The spread of different incomes among individuals and different income groups of the economy
How id consumption influenced by the distribution of income ?
Rich people have a greater proportion of income to save than poorer people
How does inflation affect consumption
Rising inflation leads to precautionary consumption (decrease) or can have the opposite effect as households decide to spend more immediately
What is the equation of savings
Income -costs
What is the equation of the personal savings ratio
Realised or actual personal saving/personal disposable income
What does the personal savings ratio measure?
The actual or realised saving of the personal sector as a ratio of total personal sector disposable income
How are savings and investments different
Saving is income not spend on consumption
Investment is spending on capital goods
Physical and financial investment are different
What is financial investment
Financial assets such as shares and bonds
Who usually saves and who usually invests
Saves: households
Invests: firms
What are the two parts of a country’s gross investment?
Replacement investment (to make good depreciation or capital consumption)-maintains the size of capital stock e.g replacing things
Net investment which adds to capital stock
What are the two key aspects for economic growth
Investment
Technical progress
What four factors influence the rate of investment?
-interest rate
-relative prices of capital and labour
-the nature of technical progress
-the adequacy of financial institutions in the supply of investment funds
How does the relative prices of capital and labour affect investment?
When the price of capital rises firms adopt labour intensive methods
Drop on capital price leads to more investment of capital goods
How does the nature of technical progress affect investment?
Technical progress causes investment in new up to date machinery
How does the adequacy of financial institutions in the supply of investment funds affect investment?
Many investments in fixed capital goods are long term investments that yield most of their expected incomes years later
-these investments become difficult to finance
banks have been criticised for favouring short term investments over long term investments
Why do gov make bad investments
They don’t face the risk of bankruptcy as a result of a poor decision
What is the accelerator process?
A change in the level of investment in new capital goods introduced by a change in national income or output. The size of the accelerator depends on the economy’s output-capital ratio
Describe the accelerator?
When output accelerated so does investment
Vice versa
