2.2.3 + 2.2.4 The determinants of aggregate demand Flashcards
components of AD
= C + I + G + (X-M)
consumption definition
Consumer spending on real output; spending on non-durables, durables & services; the largest component of AD, usually about 60%.
factors influencing consumption
- Income: more consumer spending.
- Wealth effect
- Consumer confidence: high confidence leads to more consumer spending.
- Job security
- Interest rates: affect the cost of borrowing
- Demography: a growing population (e.g. immigration) spending more
benefits of rising consumption
- rising AD
- faster SR economic growth
- falling umeployment
- more business confidence to invest
- less spare capacity
costs of rising consumption
- inflation pressure
- CA deficit
- unbalanced growth
- more household debt
- environmental issues
savings ratio
total household savings// total household disposable income
importance of savings for econ
Savings flow into financial markets and businesses can access these funds to invest
Provides households with a cushion of financial stability and funds for the government when it needs to borrow.
paradox of thrift
Keyensian conomic theory which states that an increase in saving can lead to a decrease in economic activity and, ironically, a decrease in overall saving.
investment definition
addition to capital stock of the economy e.g. factories, machines, offices, equipment, stocks of materials used to produce other goods
Gross investment
investment before depreciation
Net investment
gross investment – depreciation
why do firms invest?
- expand business and increase output capacity
- reduce average costs
- increase efficiency and productivity
- increase competitivness
factors influencing investment
- Interest rate: lower interest rate reduces the cost of borrowing
- Availability of finance
- Demand for the final product: incentive to expand
- Business confidence
- Corporate taxes
- Business regulation: a reduction in red tape and bureaucracy for businesses can incentivise more investment
- Technological change
governemnt consumption
the day-to-day running costs of government
role of gov spending
part of fiscal policy
* change level of AD (with fiscal multiplier)
* provide public and merit goods
* correct market failures, e.g. positive consumption externalities
* influence economic regions., e.g. ‘levelling up’
* achieve greater equity in society by providing public services, including universal access to healthcare and education.
factors influencing net trade
- Real income
- Exchange rate: depreciation makes imports more expensive and exports cheaper, increase X-M
- State of global economy: strong global growth may increase demand for exports, increasing X-M
- Degree of protectionism
- Non-price competitiveness
- Price competitiveness
multiplier effect
occurs when an initial injection into the circular flow causes a bigger final increase in real national income.
negative mutliplier effect
ccurs when an initial withdrawal or leakage of spending from the circular flow leads to knock-on effects and a bigger final drop in real GDP.
multiplier coefficient
itself is found by:
Final change in real GDP / Initial change in AD
multiplier formula
k = 1/ (1-mpc)
MPC - marginal propensity to consume = change in consumption/change in income
factors influencing high mutliplier value
- Economy has plenty of spare capacity
- Propensity to import and tax is low
- High propensity to consume any extra income
factors influencing low multiplier value
- Economy is close to full capacity
- Rising demand causes inflation
- Higher inflation causes rising interest rates
evaluation of multiplier
- Difficult to know exact size of multiplier - hard to measure
- time lag
- Economists disagree over its size
- LR multiplier effect is likely higher for developing economies than for developed ones; infrastructure projects often have higher multiplier effects.
