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Economics: Theme 2 > 2.2 Aggregate demand (AD) > Flashcards

2.2 Aggregate demand (AD) Flashcards

1
Q

What does aggregate demand measure?

A

Aggregate demand measures the total demand for goods and services produced in an economy at a given price level.

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2
Q

What are the components of aggregate demand?

A

Consumption, investment, government spending and net trade.

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3
Q

What is the relative importance of the components of aggregate demand?

A
  1. Consumption (around 65% AD).
  2. Net trade.
  3. Government spending.
  4. Investment.
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4
Q

What causes a movement along the AD curve?

A

A movement along the AD curve is ONLY caused by a change in price level.

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5
Q

What is the price level?

A

The price level is the average price of goods/services in an economy.

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6
Q

What causes the AD curve to shift?

A

The AD curve will shift as a result of economic growth.

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7
Q

What happens to the AD curve when economic growth occurs?

A

The AD curve will shift to the right.

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8
Q

What happens to the AD curve when negative growth occurs?

A

The AD curve will shift to the left.

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9
Q

What is consumption?

A

Consumption represents household spending on goods/services by consumers.

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10
Q

What is the influence of disposable income on consumer spending?

A

Generally, the more money people earn, the more they spend (the consumption function).

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11
Q

What is marginal propensity to consume (MPC) and how is it calculated?

A

MPC is people’s attitude towards spending. It represents how much of an extra unit of income somebody will spend.

% change in consumption/% change in income

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12
Q

Which groups tend to have the highest MPC? (2)

A
  1. People on lower incomes.

2. People with addictions.

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13
Q

What are the non income determinants of consumption? (7)

A
  1. The Wealth Effect.
  2. Income tax.
  3. Interest rates.
  4. Consumer confidence.
  5. Expectations of future price changes.
  6. Availability of credit.
  7. Population size.
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14
Q

What is the Wealth Effect?

A

The Wealth Effect describes when an increase in the value of somebody’s assets (wealth) compels them to spend more (e.g. an increase in the value of their equity stake due to rising house prices).

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15
Q

How does income tax influence consumption?

A

If income tax is high, consumers will have less disposable income and therefore spend less.

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16
Q

How do interest rates influence consumption?

A

If interest rates are low, saving is less profitable and loans are cheaper; hence, consumption increases.

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17
Q

How does consumer confidence influence consumption?

A

If consumers feel insecure in their jobs, they are likely to buy less.

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18
Q

How do expectations of future price changes influence consumption?

A

If consumers anticipate inflation, they may choose to bring their spending forward. However, if consumers anticipate deflation, they may delay their spending.

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19
Q

How does the availability of credit influence consumption?

A

If consumers can easily acquire loans, consumption will subsequently increase.

20
Q

How does population size influence consumption?

A

If the population size increases (e.g. greater birth rate, more immigration), then consumption is also likely to increase.

21
Q

What is investment?

A

Investment is the spending by businesses in the economy.

22
Q

What is the difference between gross and net investment?

A

Gross investment is the total investment on new capital inputs in the economy. Net investment adjusts the value for gross investment for capital consumption (depreciation) e.g. maintenance costs.

23
Q

What are the influences on investment? (7)

A
  1. Rate of economic growth.
  2. Business expectations/confidence.
  3. Keynes and “animal spirits”.
  4. Demand for exports.
  5. Interest rates.
  6. Access to credit.
  7. Government and regulations.
24
Q

How does the rate of economic growth influence investment?

A

If economic growth is strong due to consumer spending, businesses will be more likely to invest as they foresee larger profits.

25
Q

How does business expectations/confidence influence investment?

A

If price levels are expected to rise, firms will invest more. If confidence is low, firms will reduce investment in capital goods.

26
Q

What are “animal spirits”?

A

“Animal spirits” are the irrational urges of businesses. They are not mathematical or predictable.

27
Q

How does the demand for exports influence investment?

A

If UK goods have a high demand abroad, firms may invest in more working capital in order to increase production.

28
Q

How do interest rates influence investment?

A

If interest rates are low, firms are encouraged to invest as loans are cheaper and they will receive a lower return on their savings.

29
Q

What is meant by “highly geared”?

A

When something is “highly geared”, it is mainly financed by loans. This often applies to capital expenditure.

30
Q

What proportion of GDP is made up of capital investment?

A

16-20%.

31
Q

How does access to credit influence investment?

A

If credit is widely available, firms can borrow loans to invest and consumers are also encouraged to spend. If credit is not widely available, firms must re-invest their profits.

32
Q

How does the government influence investment?

A

If the government chooses to grant subsidies to firms, they may choose to invest this money.
If the government increases taxation (e.g. corporation tax) firms will be less likely to invest because they will lose more of their profits.
Tariffs increase domestic consumption.

33
Q

How do regulations influence investment?

A

Regulations increase production costs and therefore reduce investment.

34
Q

What are the main influences on government spending? (2)

A
  1. Fiscal policy.

2. The trade cycle.

35
Q

What is fiscal policy?

A

Fiscal policy is the use of taxation and government spending to regulate the economy.

36
Q

What is the trade cycle?

A

The trade cycle is the rise and fall of growth in the economy, and is made up of boom, recession, slump and recovery.

37
Q

What are the top five areas of government spending?

A
  1. Social protection (£232bn).
  2. Healthcare (£141bn).
  3. Education (£99bn).
  4. Defence (£45bn).
  5. Debt interest (£35bn).
38
Q

What percentage of government spending goes towards Job Seekers’ Allowance?

A

0.67%.

39
Q

What price factors affect demand for UK exports? (3)

A
  1. Inflation.
  2. Costs of production (e.g. bureaucracy).
  3. Exchange rate (SPICED).
40
Q

What non-price factors affect demand for UK exports? (6)

A
  1. Quality.
  2. Appearance.
  3. Reliability.
  4. Brand image.
  5. Innovation.
  6. After sales service.
41
Q

How does inflation influence demand for UK exports?

A

If inflation in the UK is high, exports are less price competitive.

42
Q

How do exchange rates influence demand for UK exports?

A

If the pound is strong against other currencies, UK goods are more expensive and therefore less competitive. However, it is cheaper for the UK to import.

43
Q

What is marginal propensity to import (MPM)?

A

Marginal propensity to import measures how much of an additional unit of income would be spent on imports.

44
Q

How does the state of the world economy influence demand for UK exports?

A

If there is a global recession, countries will mainly be looking to increase domestic production in order to stimulate growth and therefore avoid importing goods.

45
Q

What is protectionism and how does it affect the demand for UK exports?

A

Protectionism is the use of government policy to shield the domestic industries or a country from foreign imports e.g. tariffs, regulations. If there is a high degree of protectionism in a country, the UK is less likely to export to them.

46
Q

What are “invisible exports”?

A

“Invisible exports” are services exported by the UK to other countries. These are less tangible than goods.

Economics: Theme 2 (6 decks)

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