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Economics AS > 2.2 > Flashcards

2.2 Flashcards

1
Q

What is aggregate demand ?

A

The total demand for goods and services within an economy

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2
Q

What does aggregate demand measure ?

A

It measures spending on goods and services by consumers, firms, the government and overseas consumers and firms.

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3
Q

What is the equation for aggregate demand ?

A

C + I + G + (X-M)

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4
Q

What is consumer spending ?

A
  • How much consumers spend on goods and services.

- This is the largest component of AD, around 65 %

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5
Q

What is investment ?

A
  • This is business spending on capital goods.

- It accounts for around 15-20% of GDP in the UK per annum

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6
Q

What is government spending ?

A
  • This is how much the government spends on state goods and services, such as schools and the NHS.
  • It accounts for 18-20% of GDP
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7
Q

What is X-M ?

A
  • Exports - imports
  • This is the value of the current account on the balance of payments.
  • A positive value indicates a surplus, whilst a negative value indicates a deficit
  • Can also be called net trade
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8
Q

What causes movement along the AD curve ?

A

A change in the price level

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9
Q

What are the reasons for the downward sloping curve ?

A
  • The wealth effect
  • The international trade effect
  • The interest rate effect
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10
Q

What does an increase in price level show ?

A

Inflation

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11
Q

What does a general decrease in price level show ?

A

Deflation

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12
Q

What does an increase in GDP mean ?

A

An increase in GDP will lead to positive economic growth, lower unemployment, a current account moving into surplus and an overall boom

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13
Q

What does a decrease in GDP mean ?

A

A decrease in GDP will lead to negative economic growth, higher unemployment, a current account moving into deficit and an overall recession.

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14
Q

What causes a shift in AD ?

A
  • It is caused by a change in the determinants of aggregate demand
  • This is C + I + G + (X-M)
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15
Q

What does a shift to the right mean ?

A

It means that aggregate demand increases: for any price level, a larger amount of real GDP is demanded

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16
Q

What does a shift to the left mean ?

A

It means that aggregate demand decreases : for any price level, a smaller amount of real GDP is demanded

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17
Q

What causes a fall in AD ?

A
  • Fall in exports (X
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18
Q

What causes a rise in AD ?

A
  • Rise in exports (X>M)
  • Depreciation in the value of the exchange rate
  • Cuts in the rate of direct and indirect taxes
  • More supply of credit being given out by creditor
  • Lower interest rates
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19
Q

What is the wealth effect ?

A

It refers to when changes in the price level affect the real value of peoples wealth

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20
Q

What happens when the price level increases (wealth effect) ?

A
  • When the PL rises, the real value of wealth falls, people then cut back on their spending
  • Movement to the left along the AD curve
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21
Q

What happens when the price level decreases (wealth effect)?

A
  • When the PL decreases, the real value of wealth increases, people increase their spending
  • Movement to the right along the AD curve
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22
Q

What is the international trade effect ?

A

It refers to the change in value of exports and imports

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23
Q

What happens when the price level increases (trade effect) ?

A
  • Rising price level produces a fall in exports and a rise in imports, so net trade falls
  • Imports are cheaper whereas exports are dearer
  • This represents a fall in quantity of output demanded which causes a movement to the left along the AD curve
  • SPICED
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24
Q

What happens when the price level decreases (trade effect) ?

A
  • Falling price level produces a rise in exports and a fall in imports so that net trade rises
  • Exports are cheaper whereas imports are dearer
  • This represents a rise in quantity of output demanded which causes a movement to the right along the AD curve
  • WPIDEC
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25
Q

What happens when the price level decreases (trade effect) ?

A
  • Falling price level produces a rise in exports and a fall in imports so that net trade rises
  • Exports are cheaper whereas imports are dearer
  • This represents a rise in quantity of output demanded which causes a movement to the right along the AD curve
  • WPIDEC
  • Movement to the right long the curve
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26
Q

What is the interest rate effect ?

A

Refers to when changes in the price level affect the rate of interest

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27
Q

What happens when the price level increases (interest rate effect) ?

A
  • If there is an increase in the price level, consumers and firms need more money to carry out their purchases and transactions
  • This leads to an increase in the demand for money which leads to an increase in rates of interest
  • This increases the cost of borrowing leading to a decrease in consumer purchases which are financed by borrowing
  • A movement to the left along the AD curve
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28
Q

What happens when the price level decreases (interest rate effect) ?

A
  • If there is a decrease in the price level, consumers and firms need less money to carry out their purchases and transactions
  • This leads to a decrease in the demand for money which leads to a decrease in rates of interest
  • This decreases the cost of borrowing leading to an increase in consumer purchases which are financed by borrowing
  • A movement to the right along the AD curve
29
Q

What factors affect consumer spending ?

A
  • Real disposable income
  • Direct taxation e.g. income tax or national insurance
  • Consumer confidence and expectations
  • The rate of interest
  • The supply of credit
  • Expectations of inflation
30
Q

What effect does real disposable income have on consumer spending ?

A

An increase in real disposable income will allow consumers to spend more. This is the most important factor affecting consumer spending.

31
Q

What effect does direct taxation have on consumer spending ?

A
  • If there is a cut in direct taxation then, other factors remaining the same, consumers will experience an increase in their disposable income and increase spending
  • In contrast, a hike in indirect taxes such as import duties or VAT will cause prices to rise and real incomes to decline and decreased spending
32
Q

What effect does consumer confidence and expectations have on consumer spending ?

A

Fears of rising unemployment and expectations of higher taxes will hit consumer sentiment and spending, it will decrease spending.

33
Q

What effect does the rate of interest have on consumer spending ?

A
  • Higher interest rates increase cost of spending on mortgages. Therefore higher rates will lead to lower spending as consumers have lower discretionary income
  • Lower interest rates may therefore lead to more consumer spending
34
Q

What effect does the supply of credit have on consumer spending ?

A

A lower supply of credit means that consumers cannot borrow to spend, thus consumer spending falls

35
Q

What effect does expectation of inflation have on consumer spending ?

A

If there are anticipated price rises you would expect there to be increases in consumer spending, particularly on durables, to avoid future price rises

36
Q

What is investment ?

A
  • Investment is the addition of capital stock that is used to produce other goods and services
  • An example of this would be investment in capital goods
37
Q

When does investment take place, in the eyes of an economist ?

A

For an economist investment only takes place if real products are created

38
Q

What is depreciation ?

A

Depreciation is the decrease in the value of stock

39
Q

What causes depreciation ?

A

Depreciation is caused by the wear of stock over time as it is used

40
Q

What is gross investment ?

A

Gross investment measures investment before depreciation

41
Q

What is net investment ?

A

Net investment is gross investment adjusted for depreciation

42
Q

What are the two different types of capital ?

A
  • Human Capital

- Physical Capital

43
Q

What is investment in human capital ?

A

Investment in the education and training of workers

44
Q

What is investment in physical capital ?

A

Investment in factories and machinery etc

45
Q

How can investment be financed ?

A
  • Retained profit

- Firms borrowing money from banks

46
Q

How does the rate of interest affect levels of investment (borrowing) ?

A
  • The higher the rate of interest, the lower the profit from any investment will be, ceteris paribus.
  • A rise in interest rates will therefore reduce the number of profitable investment projects and so firms will invest less.
  • The lower the rate of interest, the more investment projects will be profitable and so there will more investment.
47
Q

What is retained profit ?

A

Savings that firms keep and do not distribute to their owners

48
Q

How does the rate of interest affect levels of investment (retained profit) ?

A
  • The higher the rate of interest that banks offer on savings, the more attractive it is for firms to save money rather than invest it in physical capital.
  • The lower the rate of interest, the greater the incentive for firms to run down their savings and invest
49
Q

What are the determinants of investment ?

A
  • Changes in interest rates
  • Changes in business confidence
  • Changes in technology
  • Changes in business taxes
  • The level of corporate indebtedness
  • Legal changes
50
Q

How does business confidence affect investment ?

A
  • If businesses are optimistic, they spend more on investment, and the AD curve shifts to the right
  • If businesses are pessimistic, they spend less on investment, and the AD curve shifts to the left
51
Q

How do interest rates affect investment ?

A
  • Increases in interest rates raise the cost of borrowing, and force businesses to reduce investment spending financed by borrowing, and therefore the AD curve shifts to the left.
  • Decreases in interest rates mean businesses can now finance their investment spending by borrowing at a lower cost, and the AD curve shifts to the right
52
Q

How does technology affect investment ?

A

Improvements in technology stimulate investment spending, therefore causing increases in aggregate demand and the AD curve shifting to the right

53
Q

How do business taxes affect investment ?

A
  • Increasing taxes causes for investment spending to decrease and the AD curve to shift to the left
  • Decreasing taxes cause for investment spending to increase and the AD curve to shift to the right
54
Q

How does the level of corporate indebtedness affect investment ?

A
  • If businesses have high levels of debt, they would be less inclined to make investments and the AD curve shifts to the left
  • A low level of debt leads to more investment and a shift to the right on the AD curve
55
Q

How do legal changes affect investment ?

A
  • For example, small businesses often do not have access to credit, meaning they cannot borrow easily to finance investments.
  • Many developing and transition economies do not have the necessary laws that secure property rights
  • In such situations, increasing access to credit (the ability to borrow) and securing property rights would result in increases in investment spending, shifting the AD curve to the right.
56
Q

What is government spending ?

A

Government spending is expenditure by the government in to public services

57
Q

Give some examples of public services

A
  • Health
  • Education
  • Defence
58
Q

What is capital spending ?

A
  • Investment spending by the government

- e.g. on motorways and defence schemes

59
Q

What could be the effects of the economy expanding ?

A
  • The government will likely spend less :
    • Fewer people may be out of work,less spending on unemployment benefits.
    • Working households may see pay increases, less needs to be spent on other forms of benefits.
    • Some people will choose to pay for private healthcare or private education, so there may be less spendingneeded on the NHS or schools.
    • Crime levels tend to be lower when the economy is growing, so less spending needed on the police.
60
Q

How would changes in political priorities affect government spending ?

A
  • It may decide to increase or decrease its expenditure in response to changes in its priorities
  • Increased government spending means a shift to the right
  • Decreased government spending means a shift to the left
61
Q

How would changes in economic priorities affect government spending ?

A
  • Increase in government spending would shift the curve to the right
  • Decrease in government spending would shift the curve to the left
62
Q

How would changes in national income abroad affect government spending ?

A
  • Consider aggregate demand in country A, which has trade links with country B.
  • If country B’s national income increases, it will import more goods and services from country A, so country A’s exports will increase.
  • Therefore the AD curve in country A shifts to the right.
  • If, on the other hand, country B’s national income falls, it will buy less from country A, and country A’s AD curve shifts to the left.
63
Q

What is an exchange rate ?

A

An exchange rate is the price of one country’s currency in terms of another country’s currency

64
Q

How would changes in exchange rates abroad affect government spending ?

A
  • Consider again country A, and assume that the price of its currency increases
  • Country B now finds country A’s output more expensive, and so it imports less from country A; therefore, country A’s exports fall, and its AD curve shifts to the left.
  • At the same time, country A now finds country B’s output cheaper, and so it increases its imports from country B.
  • A fall in its exports and an increase in imports so that net exports, X - M, fall, and the AD curve shifts to the left.
  • In the opposite situation, where the price of country A’s currency decreases, X - M increases, and country A’s AD curve shifts to the right.
65
Q

How could you remember this when the pound is stronger?

A
  • Stronger Pound
  • Imports Cheaper
  • Exports Dearer
  • Net trade decreases (X
66
Q

How could you remember this when the pound is weaker?

A
  • Weaker Pound
  • Imports Dear
  • Exports Cheaper
  • Net trade increases (X>M)
  • AD increases
67
Q

What does ‘level of trade protection’ refer to ?

A

It refers to restrictions to international trade imposed by governments

68
Q

How would changes in the level of trade protection affect government spending ?

A
  • Suppose country A trades freely with country B (with no trade restrictions). However, country B’s government decides to impose restrictions on imports from country A.
  • Country A’s exports will fall, and its AD curve will shift to the left.
  • On the other hand, in country B, lower imports mean that the value of X - M increases, and its AD curve shifts to the right.
69
Q

When GDP is rising why will there be more tax revenue ?

A
  • More revenue from income tax, as people’s income rises, and more people are in work.
  • Extra revenue from corporation tax, as business profits rise.
  • Higher revenue from VAT / sales taxes, as people spend more on goods and services.

Economics AS (11 decks)

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