Aggregate Demand Flashcards
word definition of aggregate demand
the total amount of goods and services within a particular market at a given price level
formula of aggregate demand
C + G + I + (X-M)
what are the components of aggregate demand
- consumption
- investment
- government spending
- net exports
what is the price level
the average of current prices across the entire spectrum of goods and services produced in an economy
what causes a contraction or expansion along the AD curve
change in price level
what causes a shift in the AD curve
change in component of AD
what does consumption mean
household spending on goods and servives
what does government spending mean
spending by governments of goods + services. DOESN’T include transfer payments
what does investments mean
spending on fixed or working capital
what does net exports mean
all money earnt from selling exports - all money earned from buying imports
what 8 factors affect consumption
- wealth effect
- consumer confidence
- income taxes
- availability of credit
- population
- interest rates
- expectation of inflation
- employment
what is consumer confidence
measures the degree of optimism that consumers feel about the overall state of economy and their personal financials situation
what is disposable income
income after tax and bills
what is a recession
two successive quarters of GDP falling
what is gross investment
gross investment is before depreciation. it is the total spending by businesses on capital expenditure
what is net investment
takes into account depreciation
what is the accelerator effect
- increase consumption requires more production by firms to reach the household demand
- firms decide to increase their capacity and so spending on capital expenditure increases (leads back to an increase in consumption)
- when firms increase their capacity as a result of increased in C = accelerator effect
what is the paradox of thrift
consumers = decrease C and increase savings
firms = postpone investment
higher savings and reduced investments both have the effect of reducing demand and incomes in the circular flow, causing aggregate demand to fall. banks more willing to make loans.
what are the 7 factors effecting investment
- business expectations and confidence
- interest rates
- demand for exports
- rate of economic growth
- ‘animal spirits’
- access to credit
- the influence of government and regulations
what does ‘animal spirits mean’
emphasise the importance of confidence and the ‘gut instinct’ of firms
what is a budget deficit
when government spending exceeds the tax revenue
what is a budget surplus
when tax revenue exceed the government spending
what does stopping austerity do
stopping government spending decreasing and reducing taxes
what happens to government spending in an economic boom
- increase spending as they would have higher tax receipts - increase their popularity
- spend less on benefits and transfer payments (more households will be employed)
what happens to government spending in an recession
- increase spending on transfer payments
- decrease in tax receipts from household and firms
what is a trade surplus
when value of exports > value of imports
what is a trade deficit
when value of imports > value of exporte
what is specific tax
tax that only falls on the quantity sold and not on the fixed fee
what is ad valorem tax
taxes fall on both the fixed fee and the price per unit
if a good is price elastic what will the impact be on government tax revenue if there is a tax added on the good?
the entirety of the tax will be borne by the consumer. the government tax revenue will decrease due to then higher price of the good
what is hedging
a strategy that tries to limit risks in financial assets by buying or selling an investment to potentially help reduce the risk of loss of an existing position
what does ‘unwinding the hedge’ mean
refers to the closing trade that requires multiple steps, trade or time
what is an exchange rate
the value of a currency in comparison to other countries
what does SPICED stand for
Strong Pound
Imports Cheaper
Exports Dearer (expensive)
what is relative inflation
- relative to other countries
- if inflation is low, relative to other countries, then it is likely that our exports will be cheaper and more price competitive
what are the factors affecting the price of net trade
- exchange rates
- relative inflation
- costs of production
how does costs of production effect net trade
- cop increase = price of exports increase
- price of exports increase unless exporters accept a cut in profits
- countries without minimum wage posses a cost advantage over uk firsm
what are non-price factors that affect net trade (demand for exports)
- quality/reliability
- after sales service
- fashions/trends
- appearances
- innovation
- brand
what is the marginal propensity to import
for every addition £ earned, how much is spent on imported goods
what are the multiplier effect formulas
- 1/1-MPC
- 1/MPW
what is MPC
marginal propensity to consume - for every additional £ earned, how much is spend through consumption
what is MPW made out of
MPM + MPT + MPS
what does trickle down economics rely on
low income households will have a MPC that is close to 1
what is the multiplier effect
- when an initial change in aggregate demand has a much greater final impact on national income
- it comes about because an injection to the circular flow of income stimulates further rounds of spending
- the multiplier effect can occur when any of the components of AD initially increase due to an injection
evaluate the multiplier effect
when MPC is low, each round of spending will be less. therefore if spending is low, the income for the next person will be lower
what is the laffer curve
tax revenue by tax rate
- supports trickle down economics: by reducing tax rates you increase tax revenue
what is a negative output gap
when actual output is less than potential output
what are the effects of a negative output gap
- high unemployment rates
- low economic growth
- inflation - disinflation or deflation
what is a positive output gap
when actual output is greater than potential output
what is the effect of a positive output gap
- inflation
- increasing current account deficit (trade deficit) - ^MPC - ^M - vAD
- unsustainable
