2.2 AND 2.3 Flashcards
what is meant by aggregate demand
the total level of real expenditure on the goods and services produced within a country
what are the components of aggregate demand
- household consumption - C (consumption
- Gross Fixed Capital Investment Spending by firms - I (investment)
- government consumption - G (public services)
- exports of goods and services - X
- imports of goods and services - M
what is the formula for aggregate demand
C + I + G + (X - M)
what is the approximate figure of consumption spent in an economy, investment and government
consumption - 65%
investment - 16%
government - 15%
Exports - imports = remainder - 4%
What is meant by real disposable income
Income adjusted for inflation - tax + benefits
What is meant by average propensity to consume
The proportion of income that is spent
Household consumption
—————————————- x 100
Income
What is meant by marginal propensity to consume
The change in consumer spending following a change in income
What is meant by savings ratio
% of income that is saved
what is meant by interest rate
the cost of borrowing or the reward of saving
what happens when interest rates rise
consumption falls, and savings rise
what is meant by consumer confidence
measures how optimistic households feel about the future
what does an AD curve show?
it shows how much of a good will be consumed at each and every price level
why is an AD curve down sloping?
- the wealth effect
- the interest rate effect
- the exchange rate effect
what is meant by the wealth effect
When people spend more because the value of their assets increase
what is meant by the interest rate effect
as the price level rises, the level of real income falls, and consumers are less likely to save their income. if the levels of savings falls, then the funds available for investment also falls, pushing up the interest rate.
what is meant by the exchange rate effect
as the price level rises, UK exports look less competitive compared to foreign goods, so exports falls and imports rise. This means that net exports falls, and spending in the economy also falls.
what would cause a movement along the AD curve?
an increase or decrease in the price level
what would cause a shift in the AD curve?
a change that affects any of the components of AD
name five factors that increase consumption
- real incomes rising
- interest rates falling
- asset prices/wealth
- job security/confidence
- personal taxation falling
define investment
the purchase of fixed capital such as machinery
what is depreciation of capital?
when capital loses value over time due to wear and tear, or it becomes obselete (eg end of products lifespan)
distinguish between investment and net investment
capital needs to be replaced otherwise the value of capital stock in the economy will start to fall down due to depreciation. net investment is investment over and above the amount of investment needed to replace depreciated capital
name 7 factors that increase investment
lower interest rates high animal spirits demand for exports rises business expectation and confidence access to credit improves lower corporation taxes and business regulations high rate of economic growth
define government expenditure
in the context of AD, it refers to government purchasing of goods and services, for examples paying for hospitals
distinguish between government spending and government expenditure
government spending in the wider context includes spending on transfer payments where nothing is expected in return such as pensions and welfare payments.
define fiscal policy
taxation and spending
name three fiscal policies
income tax falling
VAT rising
corporation tax falling
what is meant by a budget deficit
when government spending is greater than tax revenue.
how does the trade cycle affect government spending
during a recession government spending increases as more people claim unemployment benefits etc. also, the government often deliberately runs a deficit in order to stimulate the economy
define exports
selling UK produced goods and services abroad, and currency flows in to the UK
define imports
buying goods and services produced abroad, currency flowing out of the UK
what is meant by net exports
exporting more than importing ( X>M )
define exchange rate
the rate at which one currency is exchanged for another
how does domestic inflation affect net exports
prices rise domestically, the UK exports look less competitive compared to similar goods produced by other countries, so net exports would fall
how does a global recession affect exports?
a global recession such as the one following the global financial crisis in 2008 causes demand for UK exports to fall
how does the domestic business cycle affect imports
during a uk recession consumption of all goods and services falls including imports
what is meant by protectionism and give examples
when a country uses barriers to trade to protect domestic industry, eg
- tariffs - tax on imports
- quotas - limits placed on the number of goods that can be imported
draw a standard Aggregate Supply curve
upward sloping
GPL y axis
Real GDP x axis
equiilibrium at GPL1 and Y1
why is the AS curve sloping
it measures the volume of goods and services produced every year and so measures the ability of the economy to produce them to meet the level of demand in the economy. in the short run, we assume that the price level can change, but factors of production are fixed. the curve is upward sloping because an increase in the price level makes production more profitable and gives firms an incentive to increase output
what factors cause a movement along the AS curve and what factors cause a shift in the AS curve
changes in the price level causes a movement along
changes in the costs of factors of production shifts the SRAS curve.
what is the relationship between short run and long run supply
LRAS shows the productive potential of the economy, SRAS holds the long run variables constant, such as productivity and technology.
identify and explain three factors that affect SRAS
increase in the wage rate - increases cost of production for firms, reduces profitability and so decreases SRAS
increase in VAT - ‘’
commodity prices - ‘’
draw a Keynesian AS curve
curve goes from horizontal to upward sloping
two AD curves AD1 and AD2 upwards on AS curve
draw a classical LRAS curve
two vertical LRAS lines, two AD curves. equilibrium at LRAS 1 at P1 and Y1
define spare capacity
when the factors of production are not working as hard as they could under normal working conditions
what part on the Keynesian AS curve represents spare capacity?
the flat part - resources arent scarce yet, so output can increase without it being inflationary.
what other diagrams show spare capacity
PPFs - a point on the PPF, and the economic cycle graph - during a recession
why is the Keynesian LRAS curve the shape it is?
flat part is the spare capacity
the upward sloping part is because there is an increase in output which causes the price level to rise, as labour becomes scarce and wages rise, and then it goes vertical at the maximum capacity in the economy.
why is the classical LRAS curve the shape it is?
output can only be increased if the whole LRAS shifts to the right, eg if there was an increase in productivity or tech improved. the LRAS shows the maximum capacity of the economy, with the given state of technology, and also that all factors of production are fully and efficiently used
explain 6 factors that would shift the LRAS
increase in the working population increase in quality of labour improvement in technology increase in productivity net investment increasing capital stock infrastructure improves
