2.2 Aggregate Demand Flashcards
1
Q
- Define Aggregate Demand; What are the components of AD?
- What is the relationship between AD and the Price Level?
- Data in 2021 of components of AD (UK) - largest expenditure
A
- total planned real expenditure on a country’s goods and services produced within an economy; C + I + G + (X-M)
- inverse relationship
- Household consumption is the largest expenditure across the UK economy (59% of total in 2021) - Govt. consumption = 22%, Investment = 20%
2
Q
- What are the 3 key reasons for the shape of AD curves (sloping downwards)
- Explain each
A
- • Real Income Effect: as price falls, income rises; increasing consumer spending• Balance of Trade Effect: fall in price level of country x will increase price of foreign country goods = rise in exports, fall in imports• Interest Rate Effect: low inflation = reduction in interest rates - less incentive to save; exchange rate may depreciate and improve export sales
3
Q
- What causes a shift in AD?
- What are “external shocks” in AD?
- What are 5 examples?
A
- Increase/Decrease in: Consumer spending (C), Investments (I), Govt. spending (G), net exports (X-M)
- unexpected events that cause changes in demand, output and employment
- • Large rise/fall in exchange rate
• recession/boom in a nation’s trading partners
• Slump in housing market
• Steep fall in of credit available to businesses + households (Global Financial Crisis 08’)
• Global health crisis (COVID)
4
Q
- What is Consumption (C)?
- What are the 4 factors affecting Consumption?
- What is the wealth effect?
A
- spending on consumer goods/services
- • Real Disposable Income
• Employment + Job Security
• Household wealth
• Confidence and Expectations (within the economy) - a rise in wealth leads to an increase in consumer demand
5
Q
- What is the importance of consumer confidence?
- Define Marginal Propensity to Consume
- How does “Animal Spirit” link to consumer confidence? (Who discovered)
A
- measures consumer attitudes of various financial situations and views on a major purchase
- change in (consumer) spending following a change in disposable income
- Keynesian Economists believe the instincts and emotions that influencing human behaviour - high consumer confidence = high MPC
6
Q
- What is the 2 types of loans? Define them
- Data on Household Debts in the UK
A
- Secured loans: a loan backed by collateral (secured assets you own)
Unsecured loans: a loan not backed by collateral (secured assets you own) - • Household debts rose sharply between 97’ to 08’ crisis (85% to 148%)
• 08/09 recession: household debt rose from £500bn to £1.45tn
• 15’-18’-20’: fell to 127%, rose to 133%, slight fall to 128.5%
7
Q
- What is household savings?; What factors influence household savings?
- Define Marginal Propensity to Save
- Data on saving gaps between households in the UK
A
- disposable income that’s not spent
• interest rates, expectation/confidence, debt, inflation, taxation - amount of additional income that is saved
- • 22’: mean household savings was £76,302, median = £12,500
• 25% of households have less than £2,100 in savings
8
Q
What is the 3 key reasons for the importance of savings? Explain them
A
- • Business survival (corporate savings provide a cushion during a recession; savings used for capital investment projects or finance for takeovers)• Funding investment (Commercial banks need savings deposits which they lend to borrowers)• Buffer of financial resources for consumers (allow households to reduce debt)
9
Q
- Define Investment (I)
- What the difference between Gross and Net Investments?
A
- spending on captial goods
- Gross Investment: total investment on new capital inputs
Net Investment: gross investment adjusted for capital consumption
10
Q
- What are the 7 Factors influencing Investment?
- What is the Accelerator Theory?
- Examples for Access to Credit and Retained Profit
A
- • Interest rates (high IR = low AD)
• Accelerator Theory (economic growth = more capital goods required = high I)
• Costs (high Cost = low I = low AD)
• Animal Spirits (confidence in economy determines I)
• The world economy (other economies boom = domestic businesses increase I)
• Access to credit (low credit = low I)
• Retained profit - • Access to credit: before 08’ crisis, loans were easily distributed - now banks are more risk averse (stingy)
• Retained profit: 70% of investments in the UK is financed through retained profit; Corporation tax could affect how much retained profit a firm has
11
Q
- What are 3 (macroeconomic) advantages of higher levels of investment? Evaluate each point.
A
- • Investment is an injection into circular flow of income - component of AD; capital goods might be imported = leakage from the circular flow• New capital aids productivity; long time lag between workers getting more capital and productivity rising• Investments supports a country’s competitiveness = increase in trade balance; other factors like level of exchange rate affect competitiveness
12
Q
- What are the top 3 highest government spendings in the UK (23’-24’)
- Why do areas experience reductions in government spending? (what policy?)
- Define budget deficit
A
- Social protection (£341bn), Health (£245bn), Education (£131bn)
- policy of fiscal austerity in an attempt to reduce the budget deficit
- government spending exceed tax revenue earnt
13
Q
- What is the difference between cyclical and structural budget deficit?
- What happens to government spending when there’s a rise in GDP?
- Why would the government likely spend less in an economic boom?
A
- • Structural: government spending exceeds tax revenue but not related to the economic cycle
• Cyclical: government spending exceeds tax revenue because the economy is in a recession - more revenue from income tax (high employment) corporation tax (business make more profit) , VAT (more consumer spending), capital gains tax (more assets brought)
- less unemployment (less spending on benefits), people may for private healthcare/education (less spending on NHS or schools), low crime rate (less spending on police)
14
Q
- What does the current government spending involve?
- What is the significance of government spending?
- What are 3 ways in which state-sector spending affect income?
A
- reoccurring spending on public services (wages of teachers, nurses)
- key component of AD, helps to provide public goods and goods with positive externalities to achieve greater equity (fairness) in society
- direct effect on welfare (state pension, unemployment benefits), create jobs in the public + private sector (lead to multiplier effect), govt. subsidies keep prices lower = improve real income of consumers who benefit
15
Q
- What is the difference between trade surplus and trade deficit?; Therefore, what happens if the imports = exports?
- Why do exports increase AD?
- Why does imports decrease AD?
Exports are counted as an _______ into the ________ ____ of income
A
- • Trade surplus: exports exceed imports
• Trade deficit: imports exceed exports
• Trade balance is 0, neutral effect on AD - high exports = high firm revenue = high employment = high investment = high AD
- high imports = high expenditure of goods from foreign firms = low demand for domestic firms = income leaving the country = low economic activity = low AD
Exports are counted as an injection into the circular flow of income
16
Q
- What are the 5 factors that affect demand for imports and exports? Explain them
A
- • Real income: high domestic income = high demand for imports• Exchange rate: SPICED (Strong Pound Imports Cheaper Exports Expensive)• State of global economy: trade partners doing well = high exports• Protectionism: use of tariffs, quotas, and other trade restrictions (tariffs = tax on imports; quota = physical limit in quantity of imports) -> reduces competition for domestic firms and creates the opportunity to expand its market shares• Quality of exports
