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Macro Economics > 2.2 Aggregate Demand > Flashcards

2.2 Aggregate Demand Flashcards

1
Q

What is aggregate demand ?

A
  • the total amount of goods and services demanded in the economy at a given time and price level
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2
Q

What is the formula for AD and what are the components ?

A

C + I + G + X-M

C= household spending on goods and services
I= investment spending (businesses ect)
G= government spending
X= exports of goods and services
M= import of goods and services

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3
Q

What does an AD curve look like ?

A
  • As general price level increases, the amount of real GDP in the economy decreases
  • general price level on y axis
  • real GDP on x axis
  • shows the inverse relationship between AD and general price level
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4
Q

Why does the AD curve slope downwards?

A
  • real income effect: as price levels fall the real value of income rises and consumer can buy more
  • balance on trade effects: a fall in the relative price of level could make foreign-produced goods/services more expensive ➡️ causing a rise in exports and a fall in imports
  • interest rate effect: if inflation is low and this leads to a reduction in interest rates ➡️ there is less incentive to save + a fall in interest rates may also cause the exchange rate to depreciate and improve export sales
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5
Q

What are movements on the AD curve caused by?

A
  • changes in price levels
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6
Q

What are shifts of the AD curve caused by?

A
  • non-price factors
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7
Q

What are examples of tailwinds ?
(increase in AD)

A

🔔shifts AD to the right/help the economy grow

  • fall in exchange rates ➡️ increased exports
  • cuts in direct + indirect tax ➡️ consumers spend more
  • increase in asset prices ➡️ people more wealthy
  • lower interest rates + increase money supply
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8
Q

What are examples of headwinds ?
(Fall in AD)

A

🔔 shifts AD to the left/makes growth difficult

  • fall in trade w/other countries: decrease net imports (X-M)
  • reductions in real govt spending
  • higher interest rates + fall in borrowing
  • lack of investment by firms
  • lack in household confidence + wealth
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9
Q

What is consumption ?

A
  • the total money spent on final goods and services by individuals
  • main sources: wages, savings, pensions and benefits
  • biggest component of the UK aggregate economy
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10
Q

What is the marginal propensity to consume?

A
  • the proportion of additional income that is spent rather than saved ie. the change in spending following a change in income
  • change in C/change in Y
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11
Q

What factors affect consumer spending?

A
  • real disposable income: if pay rises do not match inflation = less spending
  • employment and job security
  • household wealth (value of assets): sustained increase in house prices = increase in personal wealth + increased confidence + more equity from their assets eg. remortgaging house
  • expectations and sentiment: low confidence due to fear of rising unemployment + rising taxes = less spending
  • interest rates: low interest rates makes it cheaper to borrow = less savings
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12
Q

What are savings ?

A
  • the amount of a households income that is not spent
  • increased savings = decreased consumption
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13
Q

What is meant by the average propensity to save (APS) ?

A
  • what amount of money households can save as a % of their total disposable income
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14
Q

What is the multiplier effect ?

A
  • more consumption leads to even more consumption (creates jobs, in which these people will spend it ect)
  • Keynes suggested to increase govt spending if consumer spending falls ➡️ will boost the economy by spending more in which a multiplier effect will benefit the economy
  • HOWEVER does not take inflation into account
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15
Q

What is meant by household saving ratio ?

A
  • measures the amount of money households have available to save as a percentage of their total disposable income; we can also call this the average propensity to save (APS)
  • higher savings ratio (other factors remain the same) lowers consumption and AD
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16
Q

Why is consumer confidence important ?

A
  • encourages spending instead of saving
17
Q

What are savings affected by ?

A
  • interest rates
  • price expectations
  • income
  • employment
  • consumer confidence
18
Q

Whats the importance of savings?

A
  • business survival (cushion during recession)
  • funding investments
  • buffer of financial resources for consumers: savings help to smooth consumption over one’s life (especially during tough economic times), allow households to purchase ‘big ticket items’ + key source of retirement income
19
Q

What is investment ?

A
  • the purchase of goods not used today but used in the future to create wealth ie. spending on capital goods
  • eg. factories, machinery
  • important as makes the economy grow + increases production & efficiency
20
Q

Why do businesses invest ?

A
  • to replace worn out capital which has depreciated in value
  • new technology (makes firms more efficient)
  • increase in AD (firms need to increased capacity)
  • profit
  • change in interest rates and loans
  • competition
21
Q

What is gross investments ?

A

the total investment on new capital

22
Q

What is net investment

A
  • gross investment adjusted for depreciation of capital (around 75% of investment is to replace old machinery)
23
Q

What are the factors that influence investment ?

A
  • interest rates: low interest rates= easier to borrow money ➡️ more investment
  • business expectations & confidence: high confidence = more likely to invest
  • govt regulations/intervention: subsidies = more investment OR reduction in regulations = easier to invest
  • Keynes and ‘animal spirit’: low confidence = businesses + individuals save more as demand + profits are lower ➡️ cancel/postpone investments
  • corporation tax: increased c tax = decrease in investments (less money to invest with)
  • spare capacity: firms tend to invest when at max capacity so that they can grow
  • levels of competition: more competition = more investment to stay ahead of other firms/countries
  • cost of capital: lower costs = increased investment (can get more for their money)

🔔 others incl: *rate of economic growth (more growth=more investment), *access to credit (easier to borrow=increased investment), *demand for exports (increase demand=increase investment to keep up)

24
Q

What did Keynes means when saying animal spirits?

A
  • human emotion + instincts can drive financial decision making of investors and consumers in an economy
  • eg. when confidence is low people save more
25
Q

What is the accelerator effect ?

A
  • states that investment levels are related to the change of GDP
  • an increase in GDP causes a corresponding larger level of investment (due to more confidence + spending for firms therefore firms invest) HOWEVER investment is very variable + can change/fluctuate quickly
26
Q

What is fiscal policy ?

A
  • means by which a govt adjusts its spending levels and tax rates to influence an economy (affects the level of AD in the economy, output and jobs)
  • relates to decisions about: govt spending, taxation + govt borrowing
27
Q

What are the key roles of fiscal policy ?

A
  • financing areas of govt spending
  • altering the distribution of income and wealth (progressive system if higher taxes for richer)
  • providing a welfare state ➡️ safety net for families
  • managing the macro economic cycle (boom/recession/recovery cycle of an economy)
  • improving a countries competitiveness
  • tackle market failure (when markets cannot provide enough goods/services) through intervention eg. education
28
Q

What does fiscal policy do ?

A
  • used to change the pattern of spending
  • impacts the level and growth of AD, output and jobs (manipulate AD using fiscal policy is called demand management)
29
Q

What is a expansionary fiscal policy ?

A
  • happens when govt increased govt spending & reduces taxation to boost the economy ➡️ may lead to a budget deficient
  • only works when there are unemployed resources otherwise takes away from private sector (as only a limited amount of resources)- known as crowding out
30
Q

What is a deflationary fiscal policy ?

A
  • happens if taxes are increased and govt spending in reduced ➡️ may lead to a budget surplus (taxation > spending)
31
Q

What is the fiscal multiplier ?

A
  • the idea of the impact of govt spending on the economy - it multiplies through the economy (has a multiplier effect- increases spending/consumption)
    eg. unemployed gets a job ➡️ eats at a restaurant ➡️ restaurant employs more staff ➡️ new staff spend money in the economy
32
Q

What is the trade cycle ?

A
  • describes how the economy tends to exhibit recurring trends in economic growth rates (boom, slowdown, recession, recovery)
  • fluctuations in economic activities specially in employment, output and income, prices, profits etc
  • eg. when GDP increases (boom) the govt will receive more tax revenue, even if tax revenues don’t change ➡️ more rev from income tax, corporation tax, VAT + capital gains (more assets bought)
33
Q

Why when GDP rises does the govt automatically receive more tax without rising taxation ?

A

more revenue from:

  • income tax (more employed people + rising incomes)
  • corporation tax (businesses profits increase)
  • VAT
  • capital gain (people buy more assets eg. house & shares- pushing up their prices= increased value of assets)
34
Q

Why does the govt also spend less when GDP rises ?

A
  • less unemployment benefits
  • increase in household incomes
  • some people chose to work in private sector eg. private healthcare/education (less spending on wages eg. NHS)
  • crime rates tend to be lower when the economy is growing ➡️ less spending on the police
35
Q

What is net trade ?

A
  • the total value of exported goods and services minus the total value of imported products
  • ie. X - M
36
Q

What is a trade surplus and deficient ?

A

trade surplus:

  • exports > imports ➡️ AD will increase

trade deficit:

  • value of imports > value of exports ➡️ AD will decrease

value of exports = value of exports, the trade balance is 0

37
Q

What factors influence the net trade balance ?

A
  • UK real incomes: increase in incomes = increased demand + imports
  • exchange rates: rise in exchange rates = increase imports + decrease exports
  • protectionism: eg. use of tariffs & quotas to protect own industries by restricting imports, other countries encourage free trade w/no restrictions (should increase trade)
  • state of the world economy: if key export markets are booming, they are likely to demand more exports
  • non-price factors: countries more competitive due to:
    1. quality, reliability and design of product
    2. marketing & branding
    3. innovation & research & development
    4. lower costs
    (govt policy often tries to improve international competitiveness)
38
Q

How does net trade affect AD ?

A
  • the net trade balance is measured as the total value of exported goods and services minus the total value of imported products
  • a trade surplus ➡️ AD will increase
  • a trade deficit ➡️ AD will fall

Macro Economics (13 decks)

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