Aggregate Demand Flashcards
What is the formula for Aggregate Demand?
AD = C + I + G + (X-M)
What is aggregate demand?
The total demand for goods and services within a specific market at a given price level. All relates to National Expenditure
Consumption
Covers household spending on goods and services by consumers - 60% - 65% of AD
Investment
Covers investment spending on fixed capital by firms (e.g., factory) and also working capital (purchases required to produce goods)
Government Spending
Spending by the government on goods and services (e.g., NHS) - Doesn’t include transfer payments, benefits, tax credits
What is net exports?
Known as net trade. All money earned from selling exports minus all money spent on imports
What is the Price Level
Average of current prices across the entire spectrum of goods and services produced in an economy.
Contraction and Expansion
Happens when price level changes (up or down)
AD Shifts
Occurs when one of the components changes (left or right)
Consumer Confidence
- Measures how consumers feel about the state of economies and their personal finances
- Measured using GFK
- Might not happen as consumers don’t have the perfect info about the economy.
What happens when there is more demand for exports and interest rates drop?
At a lower price level, people are more likely to have more disposable income. If price level decreases, goods become more competitive so there are more exports. Exports are a component of AD, so AD will shift right. At a lower price level, interest rates usually fall so AD increases further
Factors influencing consumption
1) Wealth Effect
2) Consumer Confidence
3) Income tax
4) Availability of Credit
5) Population
6) Interest rates
7) Inflation
8) Employment
How does wealth effect impact consumption?
Increased wealth effect leads to more consumption as people are more confident
How does consumer confidence impact consumption?
Increased consumer confidence means consumption increases as people feel the purchases are safer
How do Income taxes impact consumption?
As income tax increases, consumption decreases as people have less disposable income
How does availability of credit impact consumption?
Increased availability of credit increases consumption as people have increased spending power
How does population impact consumption?
Increased population increases consumption as more products are needed
How do interest rates impact consumption?
Increased interest rates decrease consumption as goods are more expensive and saving is more appealing
How does inflation impact consumption?
Increased inflation decreases consumption as money now buys you less
How does employment/income impact consumption?
Increased employment increases consumption as workforce increases so there’s more supply of goods and more salaries
Definition of a recession?
When GDP falls for two consecutive quarters
Impact on recessions on households and firms and government
Households - Less jobs
Firms - Less investment, dividends and wages for share holders. Also, less profitable with less jobs.
Government - Less money from taxes, so less spent on benefits, public services and government workers
What is stagflation?
When the economy is struggling to grow whilst inflation increases rapidly
What does the BOE do to help recover from a recession?
- Cuts interest rates, so cheaper for businesses and houses to borrow money. This leads to more spending and growth but also more inflation
- Quantitative Easing - Also leads to more inflation
What is annuity?
It’s a fixed retirement income for the rest of your life which you can buy using some, or all, of the pension pot saved up whilst working.
They’re popular as bond yields have been rising
Influences on government spending
1) Tax receipts
2) Fiscal policies (e.g., austerity measures)
What happens to government spending during booms, recessions and depressions?
Booms - Government spending decreases (also make more from taxes). Less on benefits + transfer payments as more households are employed - LRAS shifts right
Recessions - Government spending increases (also make less from taxes). More on benefits + transfer payments as less households are employed - LRAS shifts left.
Depressions - Government spending decreases massively
Government spending on transmission mechanisms practice question formatting
1) Falling economic growth -> GDP falls, go into recession -> more unemployment and benefits needed -> increased government spending
2) Increase in economic growth -> GDP increases, there’s a boom -> decreased unemployments and benefits needed -> decreased government spending
3) Falling economic growth -> Less consumption -> decreased GDP -> increased unemployment and benefit payments -> households earn less -> fall in receipts for government
4) Increase in economic growth - GDP increases -> consumer confidence increases -> consumption increases further -> employment increases -> less government spending (e.g., on welfare benefits and transfer payments)
What is gross investment?
Everything before deductions
What is net investment?
Gross investment depreciation - All deductions considered
- Gives more accurate picture of ‘capital stock/capacity’
What is depreciation?
Price falling due to ‘wear and tear’
What is the accelerator effect?
Consumption increasing requires more production from firms. Eventually firms decide to increase capacity:
- E.g., capital stock
Therefore capital expenditure increases.
Thus, investment increases, capacity increases, employment increases, and therefore consumption increases -> increase in AD
- When firms increase capacity as a result of consumption increasing - this is known as the accelerator effect
What are animal spirits?
- Affects both consumption and investment
- Keynes came up with it
- Describes the importance of confidence and ‘gut instincts’ of firms relating to future businesses and macroeconomic prospects
- Can be measured in terms of consumer confidence
Animal spirits: What do firms and consumers do when they fear there will be a recession with increased unemployment and falling profits?
- Consumers save so consumption decreases
- Firms decrease investments and save
- Firms increase prices
What is the paradox shift?
When saving increases, investment decreases -> demand and incomes in the circular flow decrease -> big decrease in aggregate demand
Factors that influence Investment?
1) Rate of economic growth
2) Business expectations and confidence
3) Animal spirits
4) Export Demands
5) Interest Rates
6) Access to credit
7) Government and Regulations
How does rate of economic growth influence investment?
Increased growth leads to increased investment and thus increased confidence
How do business expectations and confidence influence investment?
Increased confidence and therefore more investment
How do animal spirits impact investment?
