2.2 - characteristics of aggregate demand Flashcards
what is aggregate demand?
-the total demand for all goods and services in an economy at a given price level
how is the value of AD calculated?
expenditure approach
- AD = C + I + G +[X-M]
consumption, investment, gov spending and net exports
components of aggregate demand?
-consumption [60%]
-investment [15%]
-gov spending [25%]
-net exports [1%]
what is net exports?
-the difference between the revenue gained from exports and the expenditure of imports
3 reasons why the AD curve is downward sloping?
-the interest rate effect
-the wealth effect
-exchange rate effect
interest rate effect?
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-at higher average price levels, there are likely to be higher interest rates –> higher IR = reduced investment = reduction real output demanded
the wealth effect?
- as AP increases, purchasing power of households decreases and AD falls
exchange rate effect?
-as AP falls, IR likely to fall too –> lower IR = lower exchange rates
movement along the AD curve?
-increase in AP = contraction of real DGP from Y to Y1
-decrease in AP = expansion of real GDP from Y –> Y2
2.2.2 [consumption]
what is income?
-transfer of value received over a set period of time in exchange for services/products
disposable income?
-the income than an individual receives after having paid any direct taxes and received any payments/benefits
discretionary income?
-income left after tax and other necessity payments
endogenous consumption?
-C determined by level of income
exogenous consumption?
-C irrespective of income
marginal propensity?
MPS AND MPC
the proportion of each additionl unit of income that is consumed
consumer confidence? [CC]
-more likely to borrow –> secure job, low inflation
-a stronger economy = increased CC
-feel secure in job, make regular payments
-MSC increases
-opposite in a recessionary economy
influences on consumer spending?
-changes to IR
-changes in consumer confidence
-changes to wealth
how do changes to IR influence consumer spending?
-higher IR = greater incentive to save = less consumption
-if IR increases, monthly payments can increase
when saving you receive IR
what is the positive wealth effect?
-rising property prices gives consumers confidence to borrow more money to spend
2.2.3 [investment]
what is investment?
-the addition to the capital stock of the economy
what is the gross investment?
-measures investment before depreciation
what is the net investment?
-measures investment after depreciation
what is depreciation?
-fall in the value of an asset over a period of time
what does investment do to an economy?
-helps to increase its capacity [production possibilities]
increased capacity = increased potential economic growth
4 key influences on the decision by firms to invest?
-rate of economic growth
-interest rates
-demand for exports
-influences of gov and regulations
-firms will choose to invest if they feel they will make a good return on their investment
rate of economic growth on affecting decision to invest?
-increasing growth sends a signal that higher output will generate higher profits
-faster economic growth the greater the urgency to invest
interest rates on affecting decision to invest?
-most investment by firms is financed through business loans
-decreasing IR encourages investment
-there is a mostly inverse relationship between investment and IR
demand for exports on affecting decision to invest?
-if demand for E increase, firms will be more likely to invest to meet the global demand
-demand for E can increase in the exchange rate increases
influence of gov intervention and regulations on affecting decision to invest?
-gov intervention can increase investment
-gov regulation can decrease investment [raise cost of production and lower profits]
other influences of investment?
-business expectations
-keynes and animal spirits
-access to credit
business expectations and confidence?
-the longer a period of economic growth, higher confidence
-if growth slows, future expectations of profits will decrease and investment decisions will become harder
Keynes and animal spirits?
-believed firms exhibit too much optimism in the good times and took too many risks
-they run with the mood of the economy and make less rational investment decisions as they follow the trend
access to credit?
-the easier the access to loanable funds the higher the levels of investment
2.2.4 [gov expenditure]
what is gov expenditure influenced by?
-trade/business cycle and spending linked to achieveing policy aims
influence of trade/business cycle?
-unemployment decreases with a booming economy leading to lower levels of means tested benefits
-tax revenue increase with a booming economy and can be used to pay back gov debt or increase spending on public goods
influence of fiscal policy aims?
-fiscal policy announced during presentation f gov’s budget
-expenditure directly related to gov’s objectives and policy aims
2 aspects to consider in regards to fiscal policy?
-1- gov’s manifesto commitments
2- gov may use fiscal policy to manage events or crisis to support economy
injection?
Gov expenditure
withdrawals?
-taxation
2.2.5 [net trade]
what is a floating exchange rate?
-demand and supply determine the rate at which one currency exchanges for another
what is a fixed exchange rate?
-the country’s exchange rate is fixed in relation to say, the US dollar
what is appreciation?
-when the value of the currency increases [floating exchange rate system]
[re-evaluation in fixed exchange rate]
what is depreciation?
-when the value of the currency decreases
-devaluation used under fixed exchange rate
what will happen to net trade balance after increase in real income?
-imported goods are usually normal goods, therefore an increase in demand for imports and worsening the UK’s net trade balance
changes to exchange rates;
what happens when value of currency falls?
–price of imports increases
–price of exports will decrease
changes to ER;
what happens when value of currency increases?
-price of imports will decrease
-price of exports will increase
changes to exchange rates;
what happens in the long run?
-fall int he value of currency is likely to improve net trade
short run = inelastic
long run = elastic
what is protectionism?
-restriction on free trade such as tariffs and quotas
-will impact net trade balance
what do tariffs do?
-increase taxes
-shift AS to the left
what do quotas do?
-increase scarcity
-reduce AS to the left
2.2.4
what is gov spending?
-an injection
what is taxation?
- a withdrawal
what is a fiscal deficit?
G-T > 1
–> gov spending is above tax revenue
-the annual amount of borrowing undertaken by the government
decrease in taxation?
AD
decrease in tax = increased income/profit [can lead to increased imports] –>increased investment or consumption –> increased AD
increase in gov spending?
increased spending —> increased AD
