2.2.1-5 Aggregate Demand and Components Flashcards
Define Aggregate Demand
The total amount of spending on goods or services in a period of time
Identify the components of AD
C+I+G+(X-M) Consumption + Investment + Government Spending + (Exports - Imports)
How significant are the components of AD?
Consumption is the most significant with 65%, Investment has a further 15%, Government Spending has 15-20%, and the remainder is Exports and Imports
What does an AD curve show?
It shows the relation between the general price level and income. It shows the amount of goods that will be consumed at a specific price.
Why is an AD curve sloping?
1) The wealth effect- as the price level rises the income level decreases so less can be consumed
2) The interest rate effect- as price level rises, income falls meaning people are less likely to save. As savings decrease the funding for investment decreases, pushing up the interest rate. As investment is a component of AD this means that spending falls too
3) The exchange rate effect- As prices rise in the UK exports look less competitive compared to foreign goods causing exports to fall and imports to rise. As net X-M is a component of AD which is decreasing this causes spending to decrease
What would cause a movement along the AD curve?
An increase in price level is the only thing that causes a contraction or expansion in the price level.
What would cause a shift in the AD curve?
A change that effects any or all of the components of AD or the demand in the economy
Name 5 factors that would affect consumption
Real income rising, Interest rates, Job security, Asset prices, Personal tax falling
Define Investment
Investment is the purchase of fixed capital such as machinery
What is a depreciation of capital?
This is where the value of the machine, for example, will decrease over time as it is used more and ages
Distinguish between investment and net investment
Capital needs to be replaced otherwise the value of stock will decrease due to depreciation. Net investment is the investment over and above the investment needed to replace old capital.
Name 7 factors that will increase investment
—› Low interest rates —› Animal Spirits —› Demand for exports rise —› Access to credit improves —› Lower tax and business regulations —› A high rate of economic growth —› Business expectations and confidence
Define Government expenditure
This refers to the government purchasing goods and services, I.e. NHS, public services
Distinguish between government spending and government expenditure
Government spending includes things such as welfare payments and pensions which are included in consumption not Government Expenditure.
Define fiscal policies
Fiscal Policy is government spending and taxation.
Name 3 fiscal policies
- VAT tax increasing
- Income tax falling
- Corporation tax falling
What is meant by budget deficit?
When government spending › Taxation
How does the trade cycle affect Government expenditure?
In a recession government spending will increase as there are more people claiming JSA due to the increased rate of unemployment. This is because business are not maximising their output meaning they don’t need as many employees and are unable to pay their wages forcing them to let some of their worker go.
Define Exports
Exports are the goods sold from the UK to foreign companies. Currency flows into the UK
Define Imports
Imports are all the goods purchased by the UK from foreign companies. Currency flows out of the UK
What is meant by Net Exports?
When X›M
Define Exchange Rate
The exchange rate is the value of one currency for the purpose of conversion to another.
Explain the affect on the current account in the sterling exchange rate
If there is a strong pound then the price of imports are lower as the UK is able to buy more for their money however it causes exports to be more expensive, making them less competitive. Overall, this will result in a current account deficit as M›X.
How does domestic inflation affect net exports?
Prices will rise domestically which makes exports less competitive resulting in net exports to decrease.
How does a global recession affect net exports?
A global recession would cause most countries to source their products domestically causing net exports to decrease.
How does the domestic business cycle affect net imports?
During a UK recession the UK will source their goods internally as imports would be more expensive. Therefore causing imports to fall.
What is meant by protectionism and give examples?
Protectionism is when a country uses barriers to trade to protect domestic industries i.e. tariffs and quotas
