2.2 Aggregate Demand Flashcards
What is aggregate demand
Aggregate demand (AD) is the total level of spending in the economy at any given price
What is the formula for calculating aggregate demand
Aggregate demand = Consumption + Investment + government spending + (exports - imports)
What is consumption
Consumption is consumer spending on goods and services
What is investment
Investment is spending by businesses on capital goods, such as new equipment and buildings as well as working capital
What is government spending
Government spending is spending by the government on providing goods and services, generally public and merit goods.
What is net exports
Net exports is exports minus imports
What does the AD curve show
it shows the relationship between price level and real GDP. the AD curve is downward sloping as a rise in prices causes a fall in real GDP and there are four key reasons for this:
What are the four reasons for the inverse relationship between real GDP and price level in the aggregate demand curve
Income effect
Substitution effect
Real balance effect
Interest rate effect
What is the effect of income on the AD curve
As a rise in prices is not matched straight away by a rise in income, people have lower real incomes so can afford to buy less, leading to a contraction demand.
What is the effect of substitution on AD
If prices in the UK rise, less foreigners will want to buy British exports and more UK residents will want to buy imported foreign goods because they are cheaper. The rise in imports and fall of exports will decrease net exports so AD will contract.
What is the effect of the real balance on AD
A rise in prices will mean that the amount people have saved up will no longer be worth as much and so will offer less security. As a result, they will want to save more and so reduce their spending, causing a contraction in AD.
What will a be result of a change in interest rates on AD
Rising prices mean firms have to pay their workers more and so there is higher demand for money. If supply stays the same, then the ‘price of money’ i.e. interest rates will rise because of this higher demand. Higher interest rates mean that more people will save and less will borrow and will also mean that businesses invest less, so AD will contract.
What is disposable income
the money consumers have left to spend, after taxes have been taken away and any state benefits have been added
What is the marginal propensity to consume
how much an increase in income affects consumption
What is the average propensity to consume
the average amount spent on consumption out of total income.
What is the calculation for MPC
Change in consumption/ change in income
What is the calculation for APC
Total consumption/ total income
What is the relationship between saving and consumption
The more money that is saved the less consumption occurs. The same factors effect both but in opposite ways
What is the marginal propensity to save
how much of an increase in income is saved
What is the average propensity to save
the average amount saved out of income.
What is the calculation for MPS
Change in savings/ change in income
What is the calculation for APS
Total saving/ total income
What are 5 factors which effect consumer spending
- interest rates
- consumer confidence
- wealth effects
- distribution of income
- tastes and attitudes
What are some influences on investment
Rate of econmics growth
Demand for exports
Interest rates
Influence of the government and regulations
Technological change
Costs
Access to credit
Retained profit
What is are some influences on government expenditure
- the trade cycle
- fiscal policy
- age distribution of the population
What is the influence of the trade cycle on government expenditure
Decisions on expenditure may be made in order to mange the trade cycle. In recession spending may increase and during booms it may decrease to keep the trade cycle an AD steady
What is the effect of fiscal policy on government expenditure
This is policy which provides the budget for which money can be spent and has huge impact on expenditure
What is the effect of age distribution of the population of government expenditure
Ageing population means increased spending on pensions. Young population means increase in education. The more dependents young and old determines much government spending
What are influences on net trade balance
- real income ( higher demand for goods leads to imports )
- exchange rates (strong vs weak currency)
- state of world economy ( countries UK exports to success)
- non price factors ( marketing and quality)
- goods prices (
What is net trade
The total exports minus the total imports
Draw a agitate demand diagram
Check psy math tut
What causes movements and shifts in the aggregate demand curve
A movement along the AD curve is caused by a change in prices, caused by inflation or deflation. A shift of the AD curve is caused by a change in any other variable.
How can interest rates have an effect on consumer spending
Most major expenditures are bought on credit so therefore the interest rate will affect the cost of the good for consumers. If interest rates are high, the price of the good will effectively be higher since more interest needs to be paid back and this will lead to a reduction in consumption. High interest rates also increase mortgage repayments so reduce consumption.
How does consumer confidence have an effect on consumer spending
One major factor that affects people’s spending is what they think will happen in the future. If people are confident about the future and expect pay rises, then they will continue or increase their spending. If they expect high levels of inflation in the future, they will buy now as it will be at a cheaper price, so consumption will increase
How can wealth effects cause a change in consumer spending
Greater wealth will improve a consumer’s confidence and thus lead to greater spending.
How can the distribution of income have an effect on consumption
Those on high incomes tend to save a higher percentage of their income than those on low incomes and so a change in the distribution of money in the economy will affect the level of consumption. If money is moved from the rich to the poor, consumption is likely to increase as the poor have a higher MPC.
What is investment
the addition of capital stock to the economy i.e. machines and factories used to produce other goods and services. It is only seen as investment if real products are created so buying a share in a company would be saving but buying new machinery is investment.
What is gross investment
the amount of investment carried out and ignores the level of depreciation, Machinery depreciates (loses its value) over time as it wears out or gets used up
What is net investment
gross investment minus the value of depreciation, Machinery depreciates (loses its value) over time as it wears out or gets used up
What is the effect of rates of economic growth on investment
a growing economy, there will be higher levels of investment as businesses would be more confident about their investments and the higher demand would lead to a higher return rate on the investment.
What is the effect of demand for exports on investment
If the world economy is booming, demand for exports is likely to increase and therefore exporting firms’ investment is likely to increase to cope with this extra demand.
What is the effect of interest rates on investment
- Most investment is done through borrowing. High interest rates mean that borrowing is more expensive, so a business needs to be more confident of good profits in order to cover the extra costs of borrowing
What is the effect of the governments influence and regulations on investment
Governments can encourage investment by their own policy decisions. For example, they could offer tax breaks or grants to businesses to try and encourage them to invest.
What is the effect of access to credit on investment
Investment will be lower when an investment has a high risk attached to it, as it means there will be less access to credit and interest rates will be higher. In recessions, it is usually more difficult to access credit as risks are higher and banks become more risk aware, fearing firms will not be able to pay the money back.
What is the effect of retain profit on investment
Retained profits are the profits kept by a firm and not shared with shareholders or used to pay taxes. Many firms are also unwilling to borrow money for investment in case the investment fails to make a profit and they are unable to pay it back. Therefore, if firms are making higher retained profits, investment is likely to increase as they have money available to invest.
What is the effect of technological change on investment
Improvements in technology will improve or speed up production which will increase the level of profitability, meaning the investment has a better prospect of success. Change also means businesses need to invest to keep up with the best technology.
What is the effects of costs on investment
A rise in the cost of any capital project increases the level of risk that you are taking and therefore leads to lower levels of investment.
What is the effect of real income on net trade balance
When real income in the UK is high, there tends to be increased imports as people demand more goods and services and the UK is unable to meet their needs. This will mean that net trade decreases. However, if an increase in real income is due to export-led growth then net trade will increase
What are the effects of exchange rates on net trade balance
A strong pound (when the pound is worth a lot in comparison to other countries) makes imports cheap and exports dear because it costs foreigners more to buy pounds with their local currency. As a result, imports will increase and exports will decrease so net trade will decrease.
What is the effect of the state of the world economy on net trade balance
If the UK’s main export country is doing well, then UK exports are likely to rise and so net trade is likely to rise.
What is the effect of non price factors on the net trade balance
Two non-price factors which affect net trade are quality and design and marketing. If UK goods are of a higher quality and design, exports will be high as foreign demand for UK goods will increase and imports will decrease as people will buy the British goods instead of foreign goods.
What is the effect of prices of goods on net trade balance
High prices of UK goods will mean that the goods are less competitive compared to international goods since people make decisions partly based on price.
