2.2 Aggregate Demand Flashcards
Aggregate demand
Is the total amount of planned spending/ demand on goods and services at a given price level in an economy in a year
AD Equation
CIG+(X-M)
C
Consumption (most of AD)
I
Investment
G
Gov Spending
X-M
Net trade (Exports - Imports)
AD curve sloped downwards
-real balance effect
-international trade effect
-Interest rate effect
Real balance effect
When price level rises PP of cash assets fall which leads to a decrease in demand for real output
International trade affect
A rise in price level relative to other countries causes a decrease in international competitiveness causing a decrease in demand for exports and rising demand for imports
Interest rate affect
Higher interest rate reduce consumption and investment because more expensive to loan/pay back money reducing PP
Wealth affect
As income increases disposable income increases/PP consumer confidence increases stimulating AD
Movement along AD curve
-due to changes in price level
-can cause an expansion (right) or contraction (left)
Shift in A.D. curve
Shifts when any components of CIG + XM changes
Consumption
-Spending of households on goods and services
-main component equals disposable income
disposable income
-household income available from employment/private pension/ investments/welfare benefits after taxes have been deducted
Average propensity to consume
-Proportion of disposable income spent on consumer G/S -APC= consumption/disposable income x100
-average propensity to save (proportion of disposable income saved)
- APC= saving/disposable income x 100
Interest rate
Cost of Credit (borrowing)
Interest rate affecting consumption
-Credit crunch more difficult to borrow money when rises -if rises cost of borrowing increases = decreases consumption
-money in savings value increase - encourages saving
Consumer confidence influencing consumption
Future prospects has a has big influence on level of consumer expenditure i.e if think there’s going to be a recession encourages saving
Wealth effect influencing consumption
-The effect on spending when assets prices change
-increase in house price = consumers feel wealthier encourages more spending
-cost-of-living increases = disposable income decreases
Other factors influencing consumption
-Level of employment
-welfare benefits
- pension
Investment
Increase in the capital stock
gross investment
Total expenditure on new capital goods
gross investment = net investment + depreciation
Net investment
New additions to capital stock after taking into account the fall in value of capital assets
Net investment = gross investment - depreciation
-More useful than Gross - tells us improvements in prospects for economy
influences on investment
-Rate of economic growth
-business expectations and confidence
-Keynes and animal spirits
-demand for exports
-interest rates
-access to credit
-influence of government
Rate of economic growth influencing investment
-Increase in real GDP firms need more capital to meet increase demand
-increase real GDP = investment to rise and increase investment = real GDP to rise
Business expectations and confidence influencing investment
If firms expects to sell more in future more likely to invest
Keynes an animal spirits influencing investment
-Animal spirits describe instincts and emotion that may determine whether or not a firms decides to invest -decisions about whether to invest or not due to a degree of uncertainty or taken as a result of animal spirits
Demand for exports influencing investment
-Sustained increase in demand for exports is likely to stimulate investment this is also dependent on exchange rate/rules and regulations
Interest rates influencing investment
-Interest rates rise cost to borrow money = more expensive = investment falls
- however rise may not deter investment if business still think profitable
Access to credit influencing investment
Banks may be willing to take risks at low interest rates due to aftermath of 2008
Influence of government on investment
Government policy might mean taxes or subsidies affecting firms to invest or not
-e.g cut in corporation tax = firms more likely to invest
-regulations/laws could also affect investment
Government expenditure
spending by the public sector on goods and services such as education, health care and defence.
Influences on government expenditure
-Trade cycle
-fiscal policy
Trade cycle influencing government expenditure
-Trade cycle = fluctuations in GDP during recession
-government expenditure higher in recession due to e.g welfare benefits
fiscal policy influencing government expenditure
-Use of government expenditure and taxation to influence level of economic activity
-it can spend more or less than it receives from tax revenues
=E.G Looser fiscal policy = tax cuts
net trade X - M
-Exports - imports
-shows outflow/inflow of money for foreign goods and services in an economy
Influences on the net trade balance
-Real income
-changes in the exchange rate
-changes in the state of world economy
-degree of protectionism
-transport costs
Real income influencing net trade balance
-higher real incomes can lead to increased demand for imports
-trade balance weakens
Changes in exchange rate influencing the net trade balance
-Exchange rate rises/pound become stronger net exports fall = exports become less internationally competitive = cheaper to import from abroad - trade balance weakens
-however demand for exports and imports could be price inelastic
State of world economy influencing net trade balance
Trade depends on other countries economies/growth rates E.G Eurozone crisis affected exports in the UK
The degree of protectionism influencing net trade balance
other countries may have high tariffs and other restrictions making it difficult to export/import
