2.2 Aggregate Demand Flashcards
What is consumer spending?
This is how much consumers spend on goods and services. This is the largest component of AD (60% of AD)
What is Disposable Income?
The amount of income consumers have left over after taxes and social security charges have been removed.
What is Marginal Propensity to Consume?
MPC refers to the proportion of disposable income used on consumption as opposed to saving it
What is Marginal Propensity to Save?
The proportion of each additional pound of household income that is saved.
What is the equation that links MPC and MPS?
MPS + MPC = 1
How do interest rates influence consumer spending?
If interest rates are lowered, it is cheaper to borrow and also gives less reward for saving therefore spending and investment is encouraged. Lower interest rates also lower the costs of debt, such as mortgages, thus increasing the disposable income of households.
How does consumer confidence influence consumer spending?
If consumers have high confidence, they spend more because they are less concerned for the future as they have trust in the economy.
How does the Wealth Effect affect consumer spending?
A rise in the price of houses makes those who own properties feel wealthier, so they are more likely to spend more.
A consumers housing equity is the difference between the market value of a property and how much loan is remaining to be paid. If house prices increase, consumers experience a rise in equity, so they might be paying less on their mortgage than the house is worth on the market. This makes consumers feel wealthier, so they are more willing to spend.
What is gross investment?
This is the amount that a firm invests in business assets that does not account for depreciations.
What is net investment?
This is the actual addition to the capital stock of an economy, after depreciations have been considered.
Net investment = gross investment - depreciation
How does the rate of economic growth influence investment?
If growth is high firms will be making more revenue to to higher rates of consumer spending. This means they have more profits available to invest
How does business confidence and expectations influence investment?
If firms expect a high rate of return, they will invest more. Firms need to be certain about the future, otherwise they will postpone their investments.
Expectations about society and politics could affect investment.
Keynes coined the term animal spirits when describing instincts and emotions of human behaviour, which drives the level of confidence in an economy.
How does the demand for exports influence investment?
This is related to the rate of market demand. The higher the demand is, the more likely it is that firms will invest. This is because they expect higher sales, so they might direct capital goods into the markets where consumer demand is increasing.
How do interest rates influence investment?
Investment increases as interest rates falls. This means that the cost of borrowing is less and the return to lending is higher.
The higher the interest rates are, the greater the opportunity cost of not saving the money.
High interest rates might make firms expect a fall in consumer spending due to an increase in savings, which is likely to discourage investment.
How does access to credit influence investment?
If banks and lenders are unwilling to lend, such as shortly after the financial crisis when banks became more risk averse, firms will find it harder to gain access to credit, so it is either more expensive or not possible to gain the funds for investment.
However firms could use retained profits.
The availability of funds is dependent on the level of saving in the economy. The more consumers are saving, the more available fund are for lending, and therefore investing.
