2.2 AD Flashcards
Components of AD
Consumption
-spending by households on g+s
-largest contributor to economic growth
-60%
Investment
-business spending on capital goods
-15% of AD
-Machinery, buildings, technology
-Influenced by interest rates, business confidence, government policies
Gov spending
-how much the government spends on state goods and services
-Schools/ NHS
-20% of AD
X-M
-Difference between exports and imports
Relative importance of components
Consumption
-Largest component
-Most stable, less volatile
Investment
-Highly volatile especially during economic downturns
-Businesses may delay or reduce capital expenditures
Gov spending
-Policy tool to stabilise economy during recessions and boost AD
X-M
-Trade surpluses positively contribute to AD
-Deficits detract from AD
Disposable income
-Income left after taxes
-Increase in DI increases consumption
-MPC - change in spending caused by change in income
-proportion of additional dollar of income that a consumer spends
Savings and consumption
-Save more, spend less
-inverse relationship
-MPC+MPS=1
Influence of interest rates on consumer spending
-Lower rates stimulate spending because borrowing costs are reduced
Influence of consumer confidence on consumer spending
-Reflects optimism or pessimism of consumers about the future of the economy
-Higher confidence leads to higher spending so more willing to make major purchases
Wealth effects in relation to consumer spending
-Rise in price of assets makes people feel wealthier therefore they spend more
Gross vs net investment
Gross
-Total value of all new physical capital (machinery, buildings, equipment) produced or purchased over a specific time
Net
-Proportion of gross investment that represents an increase in capital stock
-Subtract depreciations (wear and tear) from gross investment
Influences of investment: rate of economic growth
-When economy is growing, businesses are more likely to invest in new capital to meet increased demand
-They make more revenue and profits available to invest due to higher consumer spending
Influences of investment: business expectations and confidence
Animal spirits
-Positive expectations about future economic conditions encourage investment
-Keynes coined term - Animal Spirits - emotional factors influencing investment decisions
-Confidence, optimism, entrepreneurial spirit can drive investment even when rational analysis might suggest caution
Influences of investment: demand for exports
-High demand can boost investment especially in export-orientated industries
-Expand production to meet demands
Influences of investment: interest rates
-Low rates reduce cost of borrowing making investment more attractive
-High interest rates reduce consumer spending which discourages investment
Influences of investment: access to credit
-If banks and lenders are unwilling to lend (after a financial crisis because they are more risk averse) it is harder to gain access to credit
-During credit crunches it is more difficult to obtain funds
Influences of investment: government regulations
-Lower corporation tax allows firms to keep more profits and use them to invest
-Subsidies encourage investment
-Regulations discourage investment and it makes doing business more difficult
How the trade cycle impacts government expenditure
-Fluctuations in economic activity that an economy experiences over a period - measured by changes in GDP and other economic indicators
Boom - economic activity is at its highest
-gov revenue stabilised
-gov receives high taxes
Recession - decreasing economic activity, falling employment and income levels
-gov revenue increases to stimulate economy through programs like unemployment benefits, or might decrease taxes
Slump - economic activity at its lowest
-gov spending at its highest to counteract
Recovery - rising economic activity, employment, income levels
-gov can reduce spending due to increased tax revenue and lower JSA spending
How fiscal policy impacts government expenditure
-During recessions expansionary fiscal policy used - increased spending and tax cuts
-During booms contractionary fiscal policy used - decreased spending and higher taxes
How real income impacts net trade
Domestic income increase:
-higher real incomes lead to increased consumption including imported goods
-potentially worsen trade balance
Foreign income increase:
-Higher real incomes abroad boost demand for exports from other countries
-improve trade balance
-Periods of economic decline, people demand less imports thus the current account may improve
How exchange rates impact net trade
Depreciation: exports cheaper, imports more expensive
-Improve trade balance
Appreciation: exports more expensive, imports cheaper
-worsening trade balance
Depends on exchange rate in regards to main trading partners
Depends on elasticity of demand for UK exports - depreciation only has effect if elastic
How state of world economy impacts net trade
-Increase in global economic growth
-Demand for g+s increases benefiting exporting countries
-Decrease in global economic growth
-demand drops affecting exporting countries
How protectionism impacts net trade
-High protectionism reduces imports improving trade balance bur risking retaliatory measures
-More open trade policies can increase imports, worsen trade balance, promote competition and efficiency
How non price factors impact net trade
-High quality, innovative products can maintain strong export performances despite price changes
-Strong brand recognition can sustain export demand
-Trade agreements can reduce barriers and enhance trade flows
