2.2.1 Aggregate Demand (AD) Flashcards
Calculation for aggregate demand
Aggregate Demand = Consumption + Investment + Government expenditure + (Exports – Imports)
AD = C + I + G + (X-M)
How does aggregate demand if there is a fall in currency value
This makes exports more competitive because it is cheaper to export and it makes imports less competitive and therefore X increases whilst M decreases therefore net trade increases and therefore so does aggregate demand.
How does aggregate demand if there is a an increase in wealth
Increase in consumption and therefore increase in AD
Aggregate Demand (AD)
The total demand in an economy over a given period of time.
What are the effects that affect ad and which component does it affect
- Wealth effect (c)
- Trade effect ( x-m)
- Interest rates [ c, I , (x-m) ]
Components of Aggregate Demand
- Consumption (C) is the total amount spent by households on goods and services.
- Investment (I) is money spent by firms on assets which they’ll use to produce goods or services. This includes machinery, computers and offices.
- Government expenditure (G) is money spent by governments.
- Net trade (X-M) is the balance between exports and imports. (exports – imports).
Aggregate Demand Curve
Why does AD slope downwards
- Real income effect: As price level falls the real value of incomes rises and consumers can buy more what they want therefore total demand increases
- Interest rate effect: If price inflation is too low then this might lead to reduction in interest rates therefore leading to an increase in borrowing and therefore more consumption
- Wealth effect: People are richer they consume more therefore AD increases
What does the price level represent on an AD diagram?
- The average level of prices in an economy.
In the UK this price level is the Consumer Price Index (inflation).
Why does the AD curve slope downwards?
The lower the price level, the more output is demanded. Lower prices mean consumers can buy more goods/services with their money.
Why will a rise in the price level cause output to fall?
- Domestic consumption will be reduced – things become more expensive, so people can purchase fewer goods and services.
- The demand for exports will be reduced - domestically produced products become less competitive.
- The demand for imports will increase – if prices haven’t risen abroad, imports will become cheaper in comparison.
Why will the AD curve shift left?
If there’s a fall in consumption, government expenditure (spending) or net exports that hasn’t been caused by a change in the price level.
For example, as a result of a rise in interest rates, or a stronger currency.
AD curve shifting left
The inward shift of the curve means that at a given price level (P), less output (T2) can be produced – but also, a given amount of output (Y) will have a lower price level (P2). There will also be a decrease in employment levels.
Why will the AD curve shift right?
If there’s a rise in consumption, government expenditure (spending) or net exports that hasn’t been caused by a change in the price level.
For example, as a result of a reduction in income tax, a weak currency, or a change in the government’s fiscal policy.
AD curve shifting right
The outward shift of the curve means that at a given price level, more output can be produced – but also, a given amount of output will have a higher price level. For example, if there’s an increase in aggregate demand from AD to AD1 – at price level P, there’s an increase in output from Y to Y1, and at output Y, the price level increases from P to P1.
Formulas for MPS and MPC
Formula for calculating the multiplier
