2.2 Aggregate Demand Flashcards
What is the AD equation?
AD = C + I + G + (X-M)
What % of AD does consumption make up?
60%
What % of AD does investment make up?
15-20%
What % of AD does net exports make up?
5%
What % of AD does government spending make up?
18-20% of GDP
Around 20% AD
What is the income effect?
Rise in prices not immediately matched by rise in income. Therefore, contraction in AD
What is the substitution effect?
If prices in UK rise, less foreigners want to buy UK goods & more UK consumers will buy imported goods. Net imports cause contraction of AD
What is the real balance effect?
Rise in prices will mean that savings are worth less - increasing MPS, contracting AD.
What is the interest rate effect?
Rising prices means firms have to pay workers more. If supply stays the same then interest rates will rise, increasing saving and reducing consumption
What is Disposable income (Y)?
Amount of income consumers have less after taxes and welfare payments
What factors affect consumption?
Disposable income
Marginal Propensity to Consume
How does income affect MPC?
Poorer people tend to have a higher MPC as they are likely to spend more of their increase in income whereas richer people tend to save it
How do you calculate MPC?
Change in consumption / change in income
How do you calculate MPS?
Change in savings/change in income
What are factors that influence consumer spending?
Interest rates
Consumer confidence
Wealth Effects
How do interest rates affect consumer spending?
Lower interest rates = more borrowing & less saving
How does consumer confidence affect consumer spending?
If people are confident about future and expect pay rises then they will spend more, due to the expectation of inflation and higher prices
How do wealth effects affect spending?
Wealth effect refers to those who have more value in assets spending more. Wealth effect experienced when house prices rise, so more confident in spending.
What’s the difference between gross investment and net investment?
Gross investment is level of investment carried out
Net investment is the gross investment - level of depreciation
(UK depreciation accounts for 75% of gross investment)
How does the rate of economic growth affect investment?
More growth = more investment as businesses more confident investment will return rewards. More demand = higher return rate
What is the accelerator theory?
Investment over a period of time is the change in real income x capital - output ratio
How does business confidence affect investment?
If businesses expect growth then they will want to invest so that they are prepared for the future
How does demand for exports affect investment?
If world economy is booming, demand for exports will increase and therefore investment for exporting firms is likely to increase.
How do interest rates affect investment?
High interest rates means that borrowing is more expensive so firms need to be more confident their investment will provide a return
How does access to credit affect investment?
If banks less willing to lend then firms will find it harder to gain access to credit, so more expensive to gain funds for investment
How does the government and regulations affect investment?
Lower corporation tax means firms keep more profit, encouraging more investment as shareholders more confident on return in investment
High regs would also discourage investment
How may gov spending be affected by a recession?
Gov spending may increase to try and boost the economy, e.g welfare payments.
How may gov spending be affected by a boom?
Gov will spend less due to less need for economic stimulation. Also gain more in tax revenue
What is discretionary fiscal policy?
Policy implemented through a one off change
What are automatic stabilisers?
Policies offset by economic cycle, do not need implementation.
What is expansionary fiscal policy?
More spending and less taxation during economic decline
What is contractionary fiscal policy?
Reduction of gov spending and increase in taxes during a boom.
How do real incomes affect trade balance?
Higher incomes usually mean more spending on imports
How do exchange rates affect trade balance?
SPICED, but depends on ped of goods
How will the state of the global economy affect the trade balance?
Fall in an export market will lead to less exports
How does the degree of protectionism affect the trade balance?
Trade deficit will reduce with tariffs etc, however could lead to retaliation
How might non price factors affect the trade balance?
Competitiveness of goods and services impacts e.g better quality, innovation etc
