3.2 Variations in economic activity Flashcards
formula for aggregate demand
Aggregate demand = C + I + G + (X − M)
What is aggregate demand (AD)?
The total demand for goods and services produced in an economy, consisting of consumption expenditure, government expenditure, investment spending, and net exports.
This is equivalent to GDP.
What is the formula for calculating aggregate demand?
Aggregate demand = C + I + G + (X − M)
C = consumption, I = investment, G = government spending, X = exports, M = imports.
What is the shape of the aggregate demand curve?
The aggregate demand curve is downward sloping.
This is similar to the market demand curve in microeconomics.
What happens to the quantity of goods and services demanded as the average price level falls?
The quantity demanded increases as the average price level falls.
This is illustrated by the movement from Y1 to Y2 in the aggregate demand curve.
What are the three reasons for the negative slope of the aggregate demand curve?
The three reasons are:
* The wealth effect
* The interest rate effect
* The net balance effect
Each effect contributes to increased demand as price levels fall.
What is the wealth effect?
As the average price level falls, the real wealth of participants in the economy increases, improving their ability to purchase goods and services.
The real value of assets such as property or stock increases.
What is the interest rate effect?
At lower price levels, interest rates decline, providing more disposable income to spend and increasing demand for output.
The incentive to save also decreases.
What is the net balance effect?
A lower price level makes goods and services cheaper for foreign countries, increasing demand for exports and decreasing demand for imports, improving the net trade balance.
This leads to a better overall economic position.
How does the aggregate demand curve differ from the demand curve in microeconomics?
The aggregate demand curve represents total output or real GDP, while the microeconomic demand curve measures the quantity of a single good.
Diminishing marginal utility does not apply to the AD curve.
What does the horizontal axis represent in the aggregate demand curve?
The horizontal axis represents the quantity of total output or real GDP.
This also reflects the total income of an economy.
True or False: The downward slope of the aggregate demand curve is influenced by diminishing marginal utility.
False.
The downward slope is due to the wealth effect, interest rate effect, and net balance effect.
Fill in the blank: Aggregate demand consists of consumption expenditure, government expenditure, investment spending, and _______.
spending on net exports.
This is part of the formula for aggregate demand.
What is the relationship between aggregate demand and GDP?
They are equivalent; aggregate demand is the same quantity as GDP.
Both measure the total economic output.
What causes movements along the AD curve?
Price level changes
Movements along the AD curve are similar to demand movements in microeconomics.
What can cause the AD curve to shift?
Changes in aggregate demand components
Aggregate demand is measured for the entire economy, unlike market demand.
What are the four components of aggregate demand?
- Consumption
- Investment
- Government spending
- Net exports
What happens to the AD curve when consumption increases?
The AD curve shifts rightward (outward)
This indicates an increase in aggregate demand.
What is one determinant of consumption that affects the AD curve?
Consumer confidence
Increased confidence shifts the AD curve rightward, while decreased confidence shifts it leftward.
How does unemployment affect consumption?
Increases concern about real incomes, potentially reducing consumption
Unemployment is closely monitored by governments.
What effect do real interest rates have on consumer spending?
Lower interest rates encourage spending; higher rates encourage saving
This influences the AD curve’s shift.
What is the difference between wealth and income?
Wealth refers to assets; income is earned through production factors
Rising asset prices can boost aggregate demand.
What effect do personal taxes have on consumption?
Lower taxes increase disposable income, shifting AD rightward
Example: 2017 Tax Cuts and Jobs Act.