Aggregate Demand Flashcards
Define and state the components of AD
Planned expenditure of G/S produced in a country.
AD = C + I + G + (X - M)
What is the difference between durable and non-durable goods?
Durable - goods that last over time (furniture, cars, TVs)
Non-durable - goods that are consumed immediately (food, fuel)
What is the difference between physical and monetary wealth?
Physical - made up of physical goods (cars, houses, land)
Monetary - non-tangible wealth (money, bank accounts)
What is the wealth effect?
When someone increases their consumption if they see the value of their wealth rise.
Describe and explain 3 causes of the wealth effect.
Increase in house prices - more can be borrowed against the value of the house.
Increase in value of stocks/ shares - consumers may sell them to spend.
Decrease in interest rates - cheaper mortgages, increase in house prices and consumption.
(can also increase share prices if returns on shares are higher than the IR)
What is the relationship between marginal propensity to consume/ save and income?
Poorer households spend most of their income on satisfying basic needs so their MPC is high. Therefore they don’t have much left to save. (low MPS)
Describe and explain 4 factors affecting consumption.
Confidence - in a recession, less spending & more saving. (fear of job loss/ debt)
Interest rates - Low IR, cheap loans, more C.
Taxation - income tax rise, less disposable income, C falls. VAT rise, prices up, real income falls, C falls.
Availability of credit - consumption depends on you much banks lend you. after the 2008 crash, they didn’t lend to high-risk firms/ consumers.
Define gross investment, depreciation, and net investment.
Gross investment - spending on additional capital stock and on replacing existing capital stock.
Depreciation - the value of stock that has been used up/ worn out.
Net investment = Gross investment - Depreciation
What are the 6 factors affecting investment?
Interest rates - low IR, cheap loans, investment rises
Animal spirits - high confidence of consumers and businesses, more investment.
Access to credit/ retained profits - if banks lend more, investment rises. Firms can also use retained profits to invest.
Demand for exports - provides revenue to invest and improve productive capacity.
Gvt regulation - subsidies allow more investment, taxes allow for less.
Rate of growth (accelerator)
What is the accelerator theory?
If output remains constant, so does investment. If the economy expands, we get net investment.
I = a (Yt - Y t-1)
What is the acceleration coefficient/ capital-output ratio?
The amount of capital needed in the economy to produce a given quantity of goods.
What are gvt transfer payments?
Money spent by the gvt moving income from one group to another rather than on G/S. (this counts as C not G)
What are the 3 factors affecting gvt spending?
Recession - gvt spending increases to increase AD, reduces u/e and gives ppl more disposable income.
Boom - gvt cuts back on spending to reduce inflationary pressures and budget deficit.
Fiscal policy - gvt spending changes depending on what they decide to prioritize.
What is the relationship between the gvt and multiplier effect?
Gvt spending is an injection into the economy that can be controlled & used to influence levels of income, u/e and inflation
They can inject into the circular flow of income to create multiplied effect of more spending -> more income.
What are the 5 factors affecting net trade?
Exchange rates - strong pound, imports cheaper, exports dearer (less competitive), net trade/ AD falls.
Interest rates - high IR, ppl save in UK banks, the value of currency and D for £s increases. SPICED.
Relative inflation - high inflation, UK £s rise, pricey exports.
Non-price factors - eg. if goods are high quality, foreigners buy them regardless of price. Net trade remains high.
Level of protection - Restrictions may be put in place to limit the no. of G/S entering the country.
What is the difference between a quota and a tariff?
Quota - limit of no. of G/S that can be imported, therefore domestic goods have to be bought instead.
Tariff - a tax on goods entering a country, increases their price making them less competitive compared to domestic goods.
What is the relationship between AD and the multiplier?
Increasing injections (I, X, G) results in a multiplied increase in AD.
Shown by the Anderton diagram, where increasing exports from Y1 to Y2 increases equilibrium output to Y3 due to multiplier.
