1.2 Aggregate demand Flashcards
What is aggregate demand?
It measures the ability and willingness of all economic agents to spend in the economy.
what are the main components of aggregate demand?
Consumption: spending on goods and services by households
Investment: spending by firms on goods and services to be used in future production
Government expenditure: Government spending on goods and services e.g NHS
Net exports: Exports minus imports
Formula: AD = C + I + G + (X - M)
What is the relationship between AD and price level?
As the price level decreases, the quantity of goods and services demanded in the economy increases.
What shifts the AD?
Things that affect one or more of the components shifts the AD curve.
What effects the components?
Consumption: if govt increases taxation then there will likely be a decrease in consumption. Also savings as the more people save the less they spend.
Investment: confidence and govt incentives can affect if a firm is willing to invest in machinery, factories etc
Govt Expenditure: govt expenditure varies depending on the govt objectives. eg NHS is uk govt main expenditure but a national health service is not common to every country.
Net Exports: When imports are greater than exports this decreases AD and visa versa
What is the relationship between income and consumption?
Income = payment from the factors of production to households. If income increases then likely consumption will increase too and will decrease if the income becomes lower. This means that the AD curve will shift. Leakages mean some households spend less than their income whilst some spend more than their income by borrowing or using past savings.
What is the proportion of income a household chooses to spend known as?
Marginal propensity consume.
Low household incomes have a high marginal propensities consume as they need to use most/ all of income to buy necessities.
High income have lower marginal propensities to consume as they have money left over after purchasing necessities
What is the relationship between income and consumption?
It depends on other variables e.g:
Overall level of income
Type of employment: flexible contracts and zero hours may be wary of increasing consumption when income goes up
Level of increase in income- a household may not respond to small changes
Confidence in future/ economy
Other factors e.g inflation
What is the role of expectations?
Views that economic agents have about what will happen to the economy in future. Important because, for example, if a supermarket expects consumption in the future then they may be more willing to open a new branch.
Expectations often more important than reality. For example if the media, without statistics to back it up, keep referring to a recession looming then households and firms will expect it and cause it to happen.
