Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

Y1 ECON > 2.2 aggregate demand > Flashcards

2.2 aggregate demand Flashcards

1
Q

what is aggregate demand?

A

the total level of spending in the economy at any given price

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

what are 4 components of AD?

A

consumption
investments
government spending
net exports

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

what % of AD is comprised of each component?

A

consumption - 60%
investments - 15%
government spending - 20%
net exports - 5%

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

explain why a 1% increase in consumption would have a bigger impact on the economy than a 1% increase in investment

A

consumption takes up a larger percentage of AD

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

gice the reasons why the AD curve is downward sloping

A

income effect
sustitution effect
real balance effect
interest rate effect

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

what could have caused a contraction in the AD curve?

A
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

what could have caused an expansion in the AD curve?

A
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

define consumption

A

spending on consumer goods and services over a period of time

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

define disposable income

A

the money consumers have left to spend , after taxes have been taken away and any state benefits have been added

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

explain the relationship between disposable income and consumption

A

the consumption function shifts forward (or upward) when disposable income or accumulated wealth also increases

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

explain the relationship between savings and consumption

A

an increase in consumption decreases savings so the same factors which affect consumption are those which affect savings - but in the opposite way. For example, a rise in confidence will decrease savings

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

how is the (household) savings ratio calculated?

A
  • the household saving rate is defined as gross household saving divided by gross disposable income, with the latter being adjusted for the change in pension entitlement of households
  • gross saving is the part of the gross disposable income which is not spent as final consumption expenditure
  • the household savings ratio is calculated by dividing household savings by household disposable income
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

give the reasons why interest rates and consumption are inversely related

A
  • 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
  • a rise in interest rates decreases the value of shares and so people experience a negative wealth effect
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

explain the relationship between confidence and consumption

A
  • 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
  • if they expect a recession and fear possible unemployment, consumption will decrease as people may save more
  • expectations about a change in the taxation level will affect consumption: if consumers expect tax to increase prices in the future, they will buy now whilst if they expect it to reduce prices in the future, they will delay their purchases
  • similarly, expectations on interest rates will affect consumption: if consumers expect interest rates to fall they may delay their purchases as things on credit will be cheaper
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

define wealth

A

a stock of assets

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

explain how changes in wealth may change consumption

A
  • people with greater wealth tend to have greater levels of consumption, known as the wealth effect: a change in consumption following a change in wealth
  • the wealth effect is experienced when real house prices rise as owners now have more wealth so are more confident with spending as they know that if they go into financial difficulty they could simply borrow more against the house, since their house is worth more than their current mortgage
  • it can also be experienced when share prices rise as people may sell some of their shares and spend the money or may be more confident in spending the money they have as they know they have the shares to fall back on in case of financial difficulty
  • greater wealth will improve a consumer’s confidence and thus lead to greater spending
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

explain how distribution of income may affect consumption

A
  • 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
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

explain how tastes and attitudes may affect consumption

A
  • in our modern society, there is a strong materialistic drive that encourages people to have the newest and the best and therefore spending can be very high, in some cases even above income
  • if people were less materialistic, consumption would decrease
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

define investment

A

the addition of capital stock to the economy i.e. machines and factories used to produce other goods and services

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

explain the difference between net and gross investment

A

gross investment - the amount of investment carried out and ignores the level of depreciation

net investment - gross investment minus the value of depreciation

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

explain the difference between capital depletion and capital depreciation

A

depletion - refers to the exhaustion of natural resources over time
depreciation - refers to the wearing out of depreciable assets

22
Q

explain the two ways in which investment may be funded

A
23
Q

define interest rates

A

a cost of borrowing money, expressed as a percentage of the amount borrowed

24
Q

explain the relationship between interest rates and level of investment

A
  • 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
  • a rise in interest rates increases the opportunity cost of a business using retained profits as they are able to get higher interest payments than before
  • Keynes’ Marginal Efficiency of Capital (MEC) graph shows how higher interest rates will lead to a fall in investment
25
Q

explain the relationship between economic growth and level of investment

A
  • in 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
  • if the economy was declining these products wouldn’t be bought so there would be no or little return on the investment
  • a growing economy needs more investment in order to cope with the higher levels of demand
  • if the same products and the same output is being produced every year, and no more is demanded, investment will stay the same as firms only have to replace old machines
  • if the economy is growing, firms will need to increase investment to match the level of demand
  • if it is shrinking, firms will not need to replace their old machines and so investment will fall
26
Q

explain the relationship between business expectations/confidence and level of investment

A
  • when businesses are confident about the future and expect future growth, investment will increase as they want to prepare for the future
  • if they are fearful of the future, then they will not invest money in new ideas or machinery
  • John Maynard Keynes used the term ‘animal spirits’ to describe the feeling of managers and owners of firms on whether their investment would be profitable - he argued that it is difficult to measure
27
Q

explain what is meant by ‘animal spirits’

A

the ways that human emotion can drive financial decision-making in uncertain environments and volatile times

28
Q

explain the relationship between demand for exports and level of investment

A
  • 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
  • this will have a knock-on effect and encourage other firms to increase their investment
29
Q

explain the relationship between the access to credit and the level of investment

A
  • 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
30
Q

explain how the government might encourage investment

A
  • 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
  • regulations also affects investment as a highly regulated economy tends to see less investment as regulation increases the cost and time taken to invest, such as planning regulations
31
Q

explain how retained profits may discourage investment

A
  • retained profits are the profits kept by a firm and not shared with shareholders or used to pay taxes
  • not all firms, particularly small firms, take into account the opportunity cost of investment from their retained profits i.e. the interest gained from keeping it in a bank account
  • 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
32
Q

explain how technological changes may encourage investments

A
  • 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
33
Q

explain how costs may discourage investments

A
  • 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
  • a rises in the costs of making goods, such as the raw materials and wage, will decrease investment as it will reduce profitability
  • this means firms have less money to invest and decreases the rate of return on their investment
34
Q

explain the significance of government spending on AD

A
  • the government has a very significant part to play in the level of AD, through spending
  • they spend money on defence, education, the NHS etc
  • the impact of a rise in government spending depends on the changes in tax: if government spending and tax rise by the same amount then there is likely to be no overall increase in demand as people have less disposable income so C decreases but G increases
35
Q

explain what is meant by government expenditure

A

spending by the government for the provision of goods/services

36
Q

what are the factors that influence government expenditure

A

the trade cycle
fiscal policy
age distribution of the population

37
Q

explain how the trade cycle influences government expenditure

A
  • in a recession, the government may increase spending in order to increase demand to reduce unemployment
  • government spending also automatically rises during a recession as they have to spend more on unemployment benefits
  • during booms, the government may decrease spending to decrease demand and reduce inflation
38
Q

explain how fiscal policy influences government expenditure

A
  • fiscal policy is the decisions about government spending and taxes and it will depend on the priorities of the government
  • the level of government spending depends on what they lay out in their fiscal policy
  • governments can vary what they spend each year, and this is set out in their budget
39
Q

explain how the age distribution of the population influences government expenditure

A
  • an ageing population leads to increased government expenditure on pensions, social care etc, whilst a young population leads to increased spending on education - the more dependents in the economy (the young and old), the higher government spending tends to be
40
Q

vi. Explain which of these two would likely result in higher Government Spending

A
41
Q

vii. Explain why this is not necessarily always the case

A
42
Q

define net trade

A

the total exports minus the total imports

43
Q

explain the difference between exports and net exports

A

exports - the value of all goods and services that a country exports
net exports - the value of all goods and services that a country exports minus the value of all goods and services that a country imports

44
Q

explain the effect of an increase in imports on AD

A

an increase in imports reduces aggregate demand in the UK economy as money flows out to foreign markets

45
Q

explain the impact of an increase in real incomes on the trade balance

A
  • 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
  • therefore, the effect of changes in real incomes is dependent on many factors
46
Q

explain the impact of appreciation of the £ on the trade balance

A
  • 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
47
Q

explain whether a depreciation of the £ would have a bigger effect if the demand for UK elastic is price elastic or price inelastic

A
  • if imports are price elastic, a rise in price will cause a large fall in demand so the value of imports will fall
  • if imports are inelastic, a rise in price only leads to a small fall in the amount of imports so the value of imports will rise
  • this is the same for exports: if prices rise and PED is inelastic then there will be a rise in value but if they are elastic then it will cause a fall in value
  • if both imports and exports are elastic, a rise in the value of the pound will lead to a fall in net trade
48
Q

explain the effect of a boom in a major trading partner on the UKs trade balance

A
  • 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
  • the effect of the state of the world economy is dependent on which countries are doing well and the trade relationship the UK has with them
49
Q

explain the effect of increasing protectionism on the UK’s trade balance

A
  • protectionism is an attempt to prevent domestic producers suffering from competition abroad
  • tariffs, quotas and technical barriers are introduced which makes it harder for producers from abroad to sell their goods in the UK
  • if there is high protectionism on UK exports in other countries, exports will decrease as it will be harder for UK firms to sell their goods in other countries
  • if there is high protectionism on imports into the UK, imports will decrease
  • if the UK imposes protectionist measures, other countries are likely to retaliate and therefore exports are likely to decrease
  • free trade means that net trade will be a more significant part of AD, whether this be in a positive or negative sense
50
Q

explain what ‘non price factors’ might affect the UK’s trade balance

A
  • 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 - this means net trade will increase
  • if UK goods are well marketed, people will have a stronger desire to buy British goods so exports will increase and imports will decrease, so net trade will increase
  • strong quality/design and marketing will mean that British exports are likely to be more inelastic
51
Q

explain how price may affect the net trade balance

A
  • 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 - this means the volume of exports will decrease and the volume of imports will increase
  • prices are affected by the inflation rate: if the UK inflation rate is higher than other countries, prices will rise faster
  • they are also affected by productivity in UK (output per worker) as higher productivity leads to lower costs and so prices will be low
  • the effects of changing prices on the value of imports and exports depends on the price elasticity of demand
  • if PED is elastic, then higher prices will lead to a fall in net trade
52
Q

evaluate the factors which could influence the importance of the relative components of AD

A

Y1 ECON (13 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions