2.2 aggregate demand (AD) Flashcards
what is aggregate demand?
the total of all demands or expenditures in the economy at a given price level
what is the equation of aggregate demand?
consumption + investment + gov. spending + net exports (exports - imports)
how do you calculate net exports?
exports - imports
what are the sources of aggregate demand?
- households
- gov
- firms/businesses
- foreigners
what are exports and imports?
- exports: products sold abroad
- imports: products brought from abroad
what are the two factors on the axes of the aggregate demand curve?
y - general price level
x - real national output
what is real income?
how much you can buy with your monetary income alongside inflation rates affected by price level - essentially purchasing power
what happens to domestic good when price levels rise?
- when price levels rise, domestic goods become more expensive
- making them less price-competitive (as people begin to look for cheaper alternatives in the international markets)
what happens to domestic good when price levels decrease?
- when price levels decrease, domestic goods become less expensive
- making them more price-competitive (they become more affordable than alternatives in the international market)
why does the AD graph slope downwards?
REAL BALANCE EFFECT: as price levels rise, the value of real income falls - consumers are less able to buy products with the monetary income they have
- a persistent rise in the price level of country X could make foreign-produced goods and services cheaper, causing a fall in exports and a rise in imports
what is the exception to the persistent increase of price levels causing the AD curve to slope downwards?
- an exception is if that country is the only source of that product; fewer substitutes available
- if other countries are also suffer from same or higher levels of inflation
- if that country’s product is of superior quality
what causes shifts in graphs?
- if there is an increase due to a third variable -> the curve shifts to the right
- if there is a decrease due to a third variable -> the curve shifts to the left
what is Y = E = O?
increased AD leads to economic graph
income = expenditure = output
what is consumption?
total expenditure by households on goods and services over a period of time
what are some factors that affect consumption?
mainly income! an increase in income leads to an increase in consumption
other factors that affect income: taxes, economic state, employment rates
what is keynesian theory of consumption?
john maynard keynes - Y is the most important determinant of C
what is disposable income?
the money remaining after you have had your taxes deducted
what is discretionary income?
the income remaining after all necessary additional taxes and necessary bills, including bills, rent, mortages and basic needs
what is the equation for disposable income?
cross-annual income - payable taxes (and other deductions)
what is the equation for income?
consumption + savings
how do income and consumption relate in terms of AD?
1) low levels of consumption
2) income tax reduced
3) all workers have more disposable income
4) workers are encouraged to spend more in shops, buying more goods
5) as a result, total consumption begins to increase. therefore AD begins to increase
what is the average propensity to consume (APC)?
ratio that tells how much much an economy spends on consumption for every dollar it consumes. consumption / income