2.2 Aggregate demand Flashcards
What is aggregate demand
The total spending in an economy at different price levels
What is the equation for aggregate demand
consumption + investment + government spending + (exports - imports)
What causes a movement along the AD curve
Change in price
What causes a shift of AD
- Changes in consumer spending
- Business investment
- Government spending
- Net exports.
What is disposable income
Income left over for an individual or household after taxes have been paid.
How does disposable income influence consumption
increased disposable income -> increase of consumption -> outward shift on AD graph
what is the relationship between savings and consumption
inversely proportional
what are 3 influences on consumer spending
- interest rates
- consumer confidence
- wealth effects
How does interest rates impact consumption
decrease in interest rates -> borrowing costs decrease -> consumers save less -> spend more -> increase consumption
How does consumer confidence impact consumption
high consumer confidence -> people are more inclined to make a big purchase -> increased consumption
How does wealth effect impact consumption
Inflation causes value of assets to increase -> consumers feel wealthier -> increase in consumption
Why might the wealth effect be invalid
Ricardo Sousa = not everyone is a homeowner, if house prices increase those who own a house will experience wealth effect -> increased consumption
those who are renters or want to purchase a house will save
those who are saving cancel out those consuming
What is the difference between net and gross investment
Gross investment = Total amount that the economy spends on new capital
Net investment = value after depreciation
What is depreciation
Measure in the loss in value of an asset over time
How is net investment calculated
Gross investment - depreciation
Describe the movements on an AD graph
decrease in price level = extension of AD (increase in GDP)
increase in price level = contraction of AD (decrease in GDP)
What influences investment
- rate of economic growth
- business confidence
- animal spirits
- demand for exports
- interest rates
- access to credit
- government and regulations
How does rate of economic growth impact investment
Economy grows at an healthy rate -> increase in demand -> increase investment in more capital
How does business confidence impact investment
High confidence in the economy -> positive expectations about future economic conditions -> increased investment
How does animal spirits impact investment
Confidence, optimism, entrepreneurial spirit increases -> decrease of rationality -> increased investment
How does demand for exports impact investment
Rising demand for exports -> encourages firms to expand to increase profit -> increased investment
How does interest rates impact investment
Low interest rates -> firms pay back less on loans -> increased investment
How does access to credit impact investment
Access to credit improves financing options for businesses -> increased investment
How does government regulations impact investment
Government insert tax incentives and subsidies -> firms have incentive to invest -> investment increase
What influences government spending
- the trade cycle
- fiscal policy
What is the trade cycle
Fluctuations in economic activities over a period of time
What is fiscal policy
Government strategies involving taxation and spending to influence the economy.
What is government spending like during a boom
Governments reduce spending due to increased tax revenues and lower unemployment benefits
What is government spending like during a bust
Government spending increases to stimulate the economy through programs like unemployment benefits and public works
What is expansionary fiscal policy
Used in recessions to boost economic activity through increased spending and cuts
What’s contractionary fiscal policy
Used during booms to cool down the economy by reducing spending and increasing taxes
What influences net trade
- real income
- exchange rates
- state of the world economy
- degree of protectionism
- non-price factors
How does domestic income impact net trade
increased real income -> increased domestic income -> increased consumption (such as imported goods) -) worsens trade balance
How does foreign income impact net trade
increased real income-> increased foreign income -> increase demand for exports -> improves trade balance
How does exchange rates impact net trade (appreciation)
Stronger domestic currency -> exports become expensive imports cheaper -> people consume more goods in foreign countries -> worsens trade balance
How does exchange rates impact net trade (depreciation)
Weaker domestic currency -> imports become expensive imports exports -> people consume more goods in domestically -> improves trade balance
How does global economic growth impact net exports
World economy is strong -> demand for goods and services increase -> exporting countries benefit -> increased exporting
What is protectionism
government actions and policies that restrict international trade to protect local businesses and jobs
How does protectionism impact net trade
