Aggregate Demand Flashcards
Definition of Aggregate Demand:
the total planned spending on real output produced within the economy
Equation for AD:
AD=C+I+G+X-M
What is AD=C+I+G+X-M?
Aggregate demand= consumption + investment + government spending + exports- imports
What causes a fall in AD?
- Cut in government spending
- Higher interest rate
- Decline in household wealth (buyer discretionary income decrease)
- Increase in house price
- Fall in exports
What causes an increase in AD?
- Expansion of supply credit
- Lower interest rates
- Increase in house price (owner wealth increase)
- Cuts in direct and indirect taxes
- Depreciation of the exchange rate
- £ down- uk export cheaper: x^
- Foreign import expensive: m down
What overall causes a change in AD:
- Changes to monetary policy
- Changes to government fiscal policy
- Business and government confidence
- External shocks
What is aggregate consumption:
Spending by all the households in the economy on consumer goods and services
Factors determining consumption:
- Interest rate
- Current level of income
- Expected future income
- Wealth
- Levels of personal debt
- Consumer confidence
- Distribution of income
- Expectation of future inflation
What is saving and when does it occur?
Its household disposable income that is not spent. Occurs when people decide to postpone their consumption until a future time
Factors affecting saving?
- Real interest rate
- Price expectations
- Availability of credit
- Unemployment/ Job security
- Consumer confidence/Expectations/Uncertainty
- Taxation on savings
- Trust in savings institutions
- Need to pay back debt
What is investment?
Planned demand for capital goods which include both physical capital and human capital
Difference between saving and investment:
Saving is income that is not spent on consumption. Savings and consumption decisions are made by households
Investment is spending by firms on capital goods such as machines and equipment. Investment decisions are made by firms
Factors affecting investment:
- Expected future sales revenue
- Expected future costs of production
- Expected future profit
- Relative prices of capital and labour
- Nature of technical progress
- Supply of investment funds
- Government policies
What is the accelerator theory?
Investment levels are related to the rate of change of GDP.
Assumption: firms wish to keep the capital output ratio fixed
When will the accelerator effect be high?
- Rate of change of consumer income and spending is strongly positive
- Amount of spare productive capacity for businesses is low
- Available supply of investment funds is high