4.2.2.3_-_The_determinants_of_aggregate_demand Flashcards
What is aggregate demand?
Aggregate demand is the total demand in the economy. It measures spending on goods and services by consumers, firms, the government and overseas consumers and firms
What is the equation for AD?
C + I + G +(X-M)
What is consumer spending?
This is how much consumers spend on goods and services. This is the largest component of AD and is therefore most significant to economic growth. It makes up just over 60% of GDP
What is real income?
the income of an individual or group after taking into consideration the effects of inflation on purchasing power
What is disposable income?
Disposable income is personal income that remains after direct taxes and government charges have been paid
Consumer income might come from wages, savings, pensions, benefits and investments, such as dividend payments.
Savings are made instead of consumption so income can either be saved or consumed
What is a consumers marginal propensity to consume (mpc)?
How much a consumer changes their spending following a change in income
What is a consumers marginal propensity to save (mps)?
The proportion of each additional pound of household income that is used for saving
A consumer’s marginal propensity to consume added to the marginal propensity to save is equal to 1
What are the main influences on consumer spending
- Interest rates
- Income levels
- Consumer confidence
- Wealth effects
- Taxes
- Level of unemployment
What is capital investment?
Money spent by firms on assets which they will use to produce goods/services e.g. capital machinery, computers and offices. It accounts for around 15% of AD in the UK
What is the difference between savings and investment?
Savings tend to be made by households, whereas investments tend to be made by firms.
What are the main influences on investment made by firms?
- Level of risk
- Government incentives and regulation
- Interest rates and access to credit
- Technical advances
- Business confidence / animal spirits
- Market demand
What is meant by animal spirits in terms of business confidence?
Business confidence depends partly on general optimism or pessimism of the company’s managers.
Not all investment decisions are based purely on reason and rational thinking, human emotion, intuition and ‘gut instinct’ are also important factors. Keynes recognised this and called these factors ‘animal spirts’
What is meant by the accelerator effect?
The accelerator effect suggests that the level of investment in an economy is related to the change in GDP. A higher rate of economic growth causes more investment.
The level of investment is more volatile than the rate of economic growth.
Firms will make an ‘accelerated’ investment in capital goods, expecting to increase output and make profit in the future
When is the accelerator effect likely to occur?
When the economy is going through recovery or at the start of a boom. These are times when demand will be rapidly increasing and firms will need to invest to meet this demand.
What is government spending?
How much the government spends on state goods and services, such as schools and the NHS.
Only money that directly contributes to the output of the economy is included. This means that transfers of money such as benefits or pensions are not included
Why might government spending not be equal to revenue?
Expansionary fiscal polices cause governments to overspend in times of economic decline to boost AD and economic growth.
Contractionary fiscal polices cause governments will spend less when the economy is experiencing booms to try and reduce AD and slow economic growth
What do governments use fiscal policies for?
To alter their spending and taxation to influence aggregate demand
What is a government budget?
A government budget outlines a government’s planned spending and revenue for the next year. Governments will either have a surplus or deficit on their budget
What are the main influences on government spending?
- The business/trade cycle
- Fiscal policy
What is the business/trade cycle?
Refers to the stage of economic growth that the economy is in. The economy goes through periods of booms and busts
Is fiscal policy a demand or supply side policy?
A demand-side policy, so it works by influencing the level or composition of AD
What is Discretionary fiscal policy?
A policy which is implemented through one-off policy changes
What are Automatic stabilisers?
Policies which offset fluctuations in the economy. These include transfer payments and taxes. They are triggered without government intervention
What is net exports?
Exports - Imports. This is the value of the current account on the balance of payments. A positive value indicates a surplus, whilst a negative value indicates a deficit. The UK has a relatively large trade deficit, which reduces the value of AD. This is the second largest component of AD
What are the main influences on net exports?
- Exchange rates
- Changes in the state of the world economy
- Degree of protectionism
- Real income
- Non-Price factors (quality of goods, operating in a niche market, competitiveness, trading blocs/trade deals)
What is protectionism?
The act of guarding a country’s industries from foreign competition. It can take the form of tariffs, quotas, regulation.
If the UK employed several protectionist measures, then the trade deficit will reduce.
Since protectionism leads to retaliation, exports might decrease too, which undoes the effect of reduced imports.
Explain an example of how the multiplier and accelerator work together
- During a recovery AD will be growing
This leads to firms increasing their levels of investment - - Which leads to another increase in AD. - This increase in AD is then ‘multiplied’, making growth in national income more rapid
- Which leads to even more ‘accelerated’ investment
How can the accelerator process and multiplier effect both happen in reverse?
During a recession, there is likely to be a fall in demand and a fall in investment, which will then have a reverse multiplier effect.
This can lead to a constant cycle of output first rising then falling
The explanation of the economic cycle is called the multiplier-accelerator model