2.2 Aggregate demand (AD) Flashcards
Aggregate demand
the total amount of spending on goods and services produced in an economy during a period of time.
AD = C + I + G + (X-M)
Consumption
total planned household spending
Disposable income
the income that households have to devote to consumption and saving, taking into account payments of direct taxes and transfer payments
Average propensity to consume
Proportion of income that households devote to consumption.
Marginal propensity to consume (MPC)
Proportion of additional disposable income households would devote to consumption
Marginal propensity to save (MPS)
Proportion of an increase in disposable income households would devote to saving
Influences on consumption
Level of real disposable income
- Rise means inc. spending & MPC
- Rise due to cut in income tax
Wealth effects
Where changes in household wealth induces changes in wealth expenditure
Households experience an inc. in the value of their assets holdings e.g. inc. house prices. MPC increases as they have the security of their property.
Consumer confidence - expectations about state of economy
Job prospects/level of unemployment, future inflation, times of recession/falling house prices
Interest rates (monetary policy) Increase in rate, inc. cost of borrowing, MPS higher
Time lags
Define wealth and income
Wealth: Accumulation of assets
Income: represents a flow
Investment
Expenditure undertaken by firms on capital goods.
Gross investment
Total investment
Gross investment = net investment plus depreciation of old capital i.e. cost of invest to replace
Net investment
Investment undertaken to increase a firms productivity capacity
Net investment = gross investment - capital depreciation
If net invest is +ve, firm will have higher prod. capacity & can meet rising demand in the future.
Macro objectives, gdp growth, inflation unemployment, balance of payemnts, ntohing overly technical , ad and as diagram, analysisi of ad and as, look at stuff of multipler!!! 10 marker will be an assess questionIn
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Influences on investment
- Business confidence & expectations
- Gov influence & regulations; taxes
- Interest rates
- Access to credit
- Improved technology
Influences on investment:
Business confidence & expectations
Business confidence & expectations - overall state of economy
Expectations about future demand; high +ve outlook incentives investment i.e. at times of rapid economic growth as to exploit opportunities for profit or when expect high rate of return.
Keynes: ‘animal spirits’
instincts & emotions that influence people when making financial decisions, drives level of confidence in the economy
Expectations not only depend on state of domestic economy but international competitiveness (exports make up for lack of demand domestically)
Rate of economic growth
Influences on investment:
Government influence & regulations
Government influence & regulations
Gov has interest in encouraging investment; expands economy prod. capacity & economic growth
- Provide incentives as tax concessions
- Uses regulation to influence location/pattern of investment
Inflation could be damaging for economy
- high rate of inflation, inc. uncertainty for future
- dampen expectations, discourage investment.
Corporation tax; tax on firms’ profits
- lower corporation tax, higher retained profit
- use retained profits to invest
Retained profit
Profit left after corporation tax has been paid
Influences on investment:
Interest rates
Rate of interest represents cost of borrowing
- if firms need to borrow & interest rates are high, they will be discouraged from investing
- marginal propensity to invest (MPI) decreases
- AD shifts left
BUT: firms can use retained profits to fund investment
- face opportunity cost
- profits can be used to buy financial assets that will provide a rate of return dependant on rate of interest
Influences on investment:
Access to credit
and improved technology
Bankers & lenders willingness to lend
- after financial crisis banks became more risk averse.
- ability of banks to provide credit depends on households who provide bank deposits through saving activity.
Improved technolgy;
inc. productivity/imporved quality
Types of government spending
Gov spend to influence economic activity
Injections, shift AD to right:
- Current spending e.g. public sector wages
- Capital spending e.g. infrastructure
- Welfare spending e.g. benefits & pensions (JSA)
Doesn’t
- Debt interest payments
Define budget deficit, surplus and national debt
Budget deficit: G > Taxation revenue in a fiscal year (April to April); borrowing in one year, after one year returns to zero
Budget surplus: G < Taxation revenue in one fiscal year
National debt: total stock of debt overtime. accumulation of budget deficit
Influences on government spending
The business/trade cycle
Recessions
- Gov inc. spending to stimulate economy
- spending on welfare payments, help people who’ve lost jobs
- cut taxes, lose revenue
- inc. gov deficit to finance this
Periods of economic growth
- Gov receive more tax revenue
- Consumers spend & earn more
- Gov. spend less, economy doesn’t need stimulating
- fewer people claim benefits
Fiscal policy - demand side policy (works by influencing level the level/composition of AD)
Involves changing gov spending & taxation
gov might spend on public goods, merit goods & welfare payments
Recession: expansionary
Economic growth: contractionary
Influences on net exports
Net exports (X-M)
Real disposable income earned abroad - State of world economy - inc. exports as MPC abroad increases - shift AD right Recession - shift AD left
Real disposable income earned home - real income
- increase imports if increases
- AD shift left
Exchange rates
SPICED & WIDEC
Depreciation of £
- more competitive
- against dollar/euro more sig effect than country’s that aren’t major UK trading partners
- imports are more expensive, exports cheaper
- current account deficit narrows
Demand for UK exports must be elastic else price change will not impact
Degree of protectionism
- Act of guarding a country’s industries from foreign comp.
- tariffs, quotas, regulations, EMBARGEOS (economic) sanctions
UK employs protectionist measures
- trade def decreases
- protectionism leads to retaliation
Non-price factors Competitiveness of country's goods & services, influenced by supply-side policies, impacts how many exports the country sells. Become more comp, by being innovative - higher qual g&s - operate in niche market - lower labour costs - be more productive - better infrastructure (all increase exports) ^ Trade deals & trading blocs (being part of trading blocs) - influences how much a country exports - either opens up a country a closes a country from sig. export opps.
