4.3 AD and AS analysis Flashcards
What is AD?
he total demand for goods and services within an economy at a given time and price
What does aggregate demand measure?
It measures spending on goods and services by consumers, firms, the government and overseas consumers and firms
What is the equation for aggregate demand?
C + I + G + (X-M)
What do the determinants mean?
Consumer spending
investment
gov spending
(exports - imports)
What does an increase in GDP mean?
An increase in GDP will lead to positive economic growth, lower unemployment, a current account moving into surplus and an overall boom
What causes a rise in AD?
Rise in exports (X>M)
Depreciation in the value of the exchange rate (WIDEC)
Cuts in the rate of direct and indirect taxes
More supply of credit being given out by creditor
Lower interest rates
What causes a fall in AD?
Fall in exports (X<M)
Appreciation in the value of the exchange rate (SPICED)
Decrease in government spending
Higher interest rates
Fall in the supply of credit
Decline in household wealth and confidence
What influences consumer spending?
Interest rates - it is cheaper to borrow and reduces the incentive to save so spending increases. However, time lags may occur, so it is not suitable if you need an immediate rise in AD. They also lower the cost of debt, such as mortgages. This increases the effective disposable income of households.
Level of real disposable income. Lower income tax etc
Consumer confidence - Consumers and firms have higher confidence levels, so they invest and spend more, because they feel as though they will get a higher return on them. If consumers fear unemployment or higher taxes, they may feel less confident about the economy
Wealth effects - in the UK, most people own their houses. This means that a rise in house prices will make people feel wealthier, so they are more likely to spend more.
Availability of credit - can’t borrow if banks aren’t willing to lend
what influences investment?
The rate of economic growth - if growth is high then firms will be making more revenue. This means they’ll have more retained profit to invest.
Business expectations and confidence - If firms expect a high rate of return, they will invest more.
Demand for exports - The higher the demand is for something, the more likely it is that firms will invest as they expect higher sales
Interest rates - Investment increases as interest rates fall. This means the cost of borrowing is less. Higher interest rates might make firms expect a fall in consumer spending which is likely to discourage investment
Access to credit - If banks are unwilling to lend, firms will find it harder to gain access to credit
Tax rates - Lower tax means firms keep more profits which could encourage investment
What influences government spending?
Debt interest repayments
Spending on infrastructure benefits pensions and maintenance of the public sector etc
The trade cycle - During recessions, the real output in the economy falls and there is negative growth. They might increase spending to try and stimulate the economy.
This could involve spending on welfare payments to help people who have lost their jobs or by cutting taxes. This will increase the gov budget deficit and they may have to finance this
What affects net exports - imports?
Real income - During periods of growth, consumers have higher incomes and can afford to consume more which means imports increase
Exchange rates - A depreciation of the pound means imports are more expensive and exports are cheaper. Depreciations make the currency relatively more competitive against other currencies. The demand for UK exports has to be price-elastic to experience an increase in exports
State of the world economy - A decline in the economy of one of the UK’s main export markets will mean the UK exports less as consumer spending in the other economies will decrease
Degree of protectionism - If a country employs lots of measures like tariffs, and quotas then the trade deficit will decrease. UK will be importing less due to the tariffs and quotas on imports to the UK
Relative inflation compared to other countries
What is Aggregate supply?
It shows the quantity of real GDP which is supplied at different price levels in an economy
Why is the AS curve upwards sloping?
This is as producers are willing to supply more because they can earn more profit
What causes the SRAS curve to shift?
This happens when there are changes in the condition of the supply
The cost of employment may change
The cost of other inputs like raw materials and exchange rates
gov regulation or intervention
What is the relationship between SRAS and LRAS ?
The SRAS only covers the period straight after a change in price level. It shows the planned output of an economy when prices change, whilst the cost of production and productivity of the factor inputs remain the same. The LRAS shows the potential supply of an economy in the long run. This is where prices and the costs and productivity of factor inputs can change. It shows the country’s productive potential. The curve is vertical because supply is assumed not to change as the price levels change.
When is the economy at a state of equilibrium?
When AD = AS. At a price above the equilibrium there will be excess supply and a price below the equilibrium is excess aggregate demand
What are some of the factors that can cause an increase in SRAS in the short run (Pneumonic)?
TRTS
Total wages paid may decrease
Raw material prices may go down
Taxes on goods and services might fall
Subsidies as they allow for production costs to decrease
What does a LRAS look like?
Either a straight line or the Keynesian version which is curved then straight.
What might cause a rise in LRAS Pneumonic?
Isquared
Increased incentive to work
Improvements in technology
What is MPC?
The willingness of a husehold to send any extra income they earn
What can affect savings?
Level of real disposable income
Interest rates. ROI on savings will be high which is an incentive to save and not spend. Increases MPS.
Level of consumer confidence. Fear recession or job loss they save as preparation
Trustworthiness of financial institutions
Tax incentives - ISA’s have a very favourable tax allowance
Age structure of population. Middle age more likely
What is the accelerator effect?
Rate of real GDP increases which increases investment which increases rate of real GDP which increases investment and so on.
What is hysterisis?
This is caused by long term unemployment where workers become discouraged and drop out the labour force.
Effect of an AD shift on the 4 key macro objectives
All depends on the initial economic position
AD shift to the right.
Increase in growth. Real gdp changes from Y1 to Y2. Firms react to increase in demand by producing more goods and services. Greater incentive. More output increases
Unemployment decreases as labour is a derived demand. When growth increases their is a greater demand for G and S and that means there will be more demand for labour
Inflation will increase as the price level increases. There is more pressure put on the existing FOPs in the economy so the price of them increases.
Trade position will worsen. Inflation is increasing so exports less competitive so demand likely to fall so reeducing exports and worsening the trade position
As a result of getting richer, people demand more stuff from abroad. Increase ca deficit
Effect of an AD shift on the 4 key macro objectives
All depends on the initial economic position
Growth increasing from Y1 to Y2. More demand now as there is an extension of AD. Firms respond by producing more output
Unemployment falling. Demand for labour increases as it is derived demand
Inflation falling. as there is less comp for these goods and services. Leads to reduced cost push inflationary pressures.
Trade position improving
What is the multiplier effect?
Any changes to the components of AD will lead to an even greater change in national output
1 / 1-MPC
1 for MPC means 100% of the extra pound being earned is spent
