4.2 A - Aggregate Demand Flashcards
Aggregate Demand
the total expenditure on an economy’s goods and services at any given price level.
consumption
total spending by consumers on domestic goods and services
Investment
Spending that increases the size of a nations capital stock
Government Spending
Spending set by the government to inject economic activity into an economy
Net exports (X -M)
Net trade component: export revenues less import expenditure
How much does consumption make of the UK’s GDP
66%
How much does investment make of the UK’s GDP
18%
How much does government spending make of the UK’s GDP
20%
How much does net exports make of the UK’s GDP
-4%
What is the equation for Aggregate demand
AD = C + I + G + (X-M)
How do you draw an AD graph
X axis - real output
Y axis - price level
What direction does the AD graph slope
Downwards - As the average price level falls, AD increases and real output increases
movement on AD graph
When the average price level in an economy changes
real output changes with the price level
Shift on AD graph
Any other relevant factors affecting AD other than price level
real output changes at every given price level
Wealth effect definition
Shows how the price level affects real incomes
Trade effect definition
Shows how the price level affects trade patterns
Interest Rates effect definition
Shows how the price level effects borrowing costs
price level definition
Buying power of money - inflation
Wealth effect short-run explained
In the short-run Income and wealth positions are unchanged
Wealth effect exaplained
price level decreases
real output increases
- people feel wealthier and spend more, increasing Consumption and movement down the AD curve
Vice versa
Trade effect explained
Assuming ceteris paribus
If domestic prices decrease –> demand for exports increases
If domestic prices decrease –> demand for imports decreases
causes movement in AD curve to the right
What is the relationship between price level and real output (AD graph)
Inversely proportional
As price level decreases real output increases
how do interest rates decrease when price level decreases
Consumers need money to purchase things… If
Price level decrease
Asset demand increases - put into savings…
As assets prices increase the return on that asset decreases
causing interest rates to decrease
Therefore
price level decrease
interest rates decrease
How does interest rate effect, effect AD
Interest rates decrease, means more borrowing
Investment increases
Consumption increases
AD moves downwards
Inward AD shift
Ad decreases at every given price level and real output is lower
outward AD shift
Increase in AD at every given price level, real output is higher
factors AD in an economy (causes shifts)
Shifts occur due to a change in an AD component which may change due to:
- Confidence
- exchange rates
- Interest rates
- Population rates
- Wealth changes
- Tax changes
Which components does confidence effect in an AD graph
- C
- I
- G
- M
- not X because thats to do with foreign demand
Which components does exchange rates effect in an AD graph
- X
- M
WPIDEC
SPICED
Which components does interest rates effect in an AD graph
-C
-I
-G
-X
-M
Which components does Population changes effect in an AD graph
- C
-I
-G
-M
Which components does Wealth changes effect in an AD graph
-C
-I
-M
Which components does tax changes effect in an AD graph
-C
-I
-M
What shifts does confidence cause on AD
Rises:
Positive AD impact
Falls:
Negative AD impact
What shifts does exchange rates cause on AD
Rises:
Negative impact on AD
Falls:
Positive AD impact
What shifts does Interest rates cause on AD
Rises:
negative AD impact
Falls:
positive AD impact
What shifts does population changes cause on AD
Rises:
Positive AD impact
Falls:
Negative AD impact
What shifts does wealth changes cause on AD
Rises:
Positive AD impact
Falls:
Negative AD impact
What shifts does Tax changes cause on AD
rises:
Negative AD impact
Falls:
Positive AD
multiplier effect
The process by which expenditure generates a trail of subsequent expenditure so that the resultant change in national income will exceed the amount initially expended.
propensity to consume
the proportion of income that is used to buy goods and services
the average propensity to consume
The proportion of total income that is consumed
= consumption / income
marginal propensity to consume
MPC
the proportion of a change in income that is consumed
= change in consumption / change in income
multiplier effect formula
1 - mpc
Marginal propensity to save
MPS
the proportion of total income that is saved
MPS + MPC
= 1
How does the multiplier effect work
> gov spends 100
–> person 1 spends 50 and saves 50
—–> person 2 spends 25 and saves 25
———> person 3 spends 12.5 and spends 12.5
assuming the MPC and MPS are the same:
initial spent = 100
multiplier of 1/0.5 = 2
total spending = 200
