2. Aggregate Demand Flashcards
What is demand?
The willingness and ability of a consumer to purchase a good or service at a given price
What does the law of demand state?
Conditional on all else being equal, as the price of a good increases, quantity demanded decreases; conversely, as the price of a good decreases, quantity demanded
What is aggregate demand?
the total spending on goods and services in an economy in a given time.
What causes a movement along the AD curve?
A change in price level in the economy
What 3 reasons cause AD to slope downwards?
1) Wealth effect: At higher prices the total demand for goods and services will be lower because consumers will feel less well-off.
2) Trade effect: As the price level increases, british goods become less competitive. Value of net exports will decrease.
3) Interest Rate effect: The higher prices are, the more interest rates will rise to cover the rise in prices. This will reduce consumer spending and investment spending as borrowing will be expensive.
How do we measure GDP/AD?
C + I + G + (X - M)
C:
What is consumption?
Why is it so significant?
What can income be?
- the total amount spent by households on G+S
- Consumption is the largest component of AD - makes up around 65% of AD in the UK
- income can either be consumed / spent or saved
C:
What are the 6 factors affecting consumption?
1) income
2) interest rates
3) consumer confidence
4) wealth effects
5) taxes
6) unemployment
I:
What is it?
What is gross investment?
What is net investment?
Why do firms invest?
How much of UK AD does it make up?
- is money spent by firms on assets which they’ll use to produce G+S
- includes all investment spending
- only includes investment that increases productive capacity
- they invest with intention of making profit in the future
- roughly 15%
I:
What are the 6 factors influencing investment?
1) Risk
2) Government Incentives (Tax/Subsidies)
3) Government Regulation
4) Interest Rates and access to credit
5) Technological Advances (staying competitive)
6) Business Confidence / animal spirits
–> Keynes recognised not all investment decisions are based purely on rational thinking, and that human emotion, intuition and ‘gut instinct’ are also important factors
G:
What is it?
What doesn’t it include?
The money spent by the government on public goods and services
doesn’t include transfers of money as it doesn’t directly contribute to the output of the economy - e.g. jobseeker’s allowance or pensions
What is a Government budget deficit vs surplus?
Deficit: G>T
Surplus: G<T
X-M:
What are exports?
What are imports?
Goods and services that are produced in one country, then sold in another.
Goods and services that are bought into a country after being produced somewhere else.
X-M:
What are the 4 factors influencing net exports?
1) Exchange rates (SPICED/WIDEC)
2) Changes in domestic and international incomes
3) Protectionism
4) Non-price factors (Quality of goods)
What is the positive multiplier effect?
When an injection is made into the circular flow, the actual change in the national income is greater than the initial injection
–> shown by AD shifting right multiple times… AD1 to AD2 to AD3 etc…
What impacts the impact of an injection and the operation of the multiplier?
On the marginal propensity to consume
What is the MPC?
Measures the proportion of extra income spent on consumption
–> it will be between 0 and 1!!
What influences the MPC?
Low and high incomes
–> lower income households have a higher MPC whereas higher income households have a higher MPS (marginal propensity to save)
Consumer Confidence
Interest rates
Demographic (younger people tend to consume more)
The higher the MPC the higher…
the final impact will be of the multiplier
If the value of the MPC is 0.8, what is the total increase to real national income, due to the multiplier process if the initial injection is 25 million pounds?
Multiplier = 1/(1-mpc)
Final Impact = initial injection x multiplier
A) 31.25m
B) 62.5m
C) 125m
D) 250m
C - 125m
1/1-0.8 = 5
5 x 25 = 125m
What is the negative multiplier effect?
occurs when an initial “leakage” from the circular flow of income leads to a greater overall reduction in economic activity
What’s the accelerator effect?
When an increase in national income (GDP) results in a proportionately larger rise in capital investment spending. In other words, we often see a surge in capital spending by firms when an economy is growing quite strongly and there is increased potential for future profits.
REMEMBER: I follows Y
