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
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
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
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
5
Q
What are movements on the AD curve caused by?
A
- changes in price levels
6
Q
What are shifts of the AD curve caused by?
A
- non-price factors
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
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
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
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
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
12
Q
What are savings ?
A
- the amount of a households income that is not spent
- increased savings = decreased consumption
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
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
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
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
What is the accelerator effect ?
- 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
What is fiscal policy ?
- 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
What are the key roles of fiscal policy ?
- 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
What does fiscal policy do ?
- 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
What is a expansionary fiscal policy ?
- 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
What is a deflationary fiscal policy ?
- happens if taxes are increased and govt spending in reduced ➡️ may lead to a budget surplus (taxation > spending)
31
What is the fiscal multiplier ?
- 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
What is the trade cycle ?
- 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
Why when GDP rises does the govt automatically receive more tax without rising taxation ?
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
Why does the govt also spend less when GDP rises ?
- 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
What is net trade ?
- the total value of exported goods and services minus the total value of imported products
- ie. X - M
36
What is a trade surplus and deficient ?
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
What factors influence the net trade balance ?
- 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
How does net trade affect AD ?
- 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
