aggregate demand Flashcards
definition of AD
Total expenditure on a country’s goods and services measuring the total spending taking place in the economy
Equation for aggregate demand
AD= C+I+G+(X-M)
Describe what happens when the price levels decrease
When the price levels decrease there is an increased / extension in aggregate demand therefore an increase in Real G D P
What causes a change in aggregate demand
If consumption, investment, government spending, net exports increase or decrease
Why is the aggregate demand curve downward sloping
Changing purely to do with reasons to do with price level
How can the downward sloping half be explained by
The wealth effect, the trade effect, the interest effect
Explain the wealth effect
If price levels decrease the purchasing power of income increases
People are richer meaning they’re more likely to spend their money on goods and services
increasing consumption
Consumption is purely increasing because price levels are changed therefore there will be an extension / contraction of aggregate demand
And the real gdp will increase or decrease
Explain the trade effect
If price levels decrease exports become more competitive and imports become less competitive
If exports become more competitive there is greater demand for exports therefore revenues generated from exports increase which increases exports
Therefore there will be less spending on imports reducing the value of M
As a result purely because of the change in the price level the value of X - M will increase and therefore increase aggregate demand and real GDP
The interest rate effect
Impacting consumption investment and net exports
If the price levels decreased interest rates can be kept lower in the economy as most central banks will adapt interest rates to meet the inflation target
If inflation is low the interest rates can be kept lower in the economy
If interest rates are lower that’s higher consumption and higher investments as the cost in borrowing is lower
Decreasing interest rates will reduce the value of exchange rates boosting exports performance
Interest rate links purely to result in changing price level
What factors cause a shift in the aggregate demand curve
For changes in components of aggregate demand consumption investment government or net exports not price
What’s a budget deficit and a budget surplus
Budget deficit means suspending of the government is greater than the taxation revenues in a year / fiscal year
Budget surplus is when the government spending is less than the taxation revenue in a fiscal year
Definition of consumption
Consumption is a total spending by households on goods and services in the economy
What’s the marginal prospensity to consume
The willingness of households to spend any extra income they earn
Factors which may affect consumption
Interest rates
Consumer confidence
Asset prices
level of household in debtedness
Level of real disposable income
Expected future income
Level of savings
Tax rates
Job security
Why would interest rates / availability of credit impact consumption
If the interest rates are caught the cost of borrowing falls and the rate of return on saving falls so the cost of borrowing falls there is an increase incentive for customers to borrow money and its cheese per to do so and spend the borrowed money on expensive items for example houses and cars
Why would consume a confidence impact consumption
If there is a high consumer confidence there is a higher marginal prosperity to consume
Asset prices impact consumption
This links to how wealthy people feel and therefore more likely to spend meaning a high marginal prosperity to consume asset prices include house prices share prices and bond prices if these increase people feel wealthier even though their income hasn’t changed
how do you level of house indebtedness Change the level of consumption
If families are living in debt they’re more likely to save their money meaning less consumption
level real disposable income impact on consumption
If there is an increase of disposable income There Will be an increase of real disposable income therefore increasing marginal prosperity to consume and increasing the level of consumption in an Economy
What’s investment
Total plan spending by firms on capital goods produced within the economy
What’s the accelerator theory of investment
The accelerator effect states that the level of planned investment is related to past change in income rather than the interest rates if it predicts that the investment spending in the economy is likely to be more volatile then spending as a whole
The effects of business investment spending
A rise in capital investment will have an effect on both demand and supply including a positive multiplier effect on national income
Demand side effects of investment spending
Increase spending on capital goods affects industries that manufactured this technology /capital
The supply side effects of investment spending
Investment is linked to higher productivity and expansion in a country’s Productive capacity reduces unit costs
Influences on investment
Interest rates
Business confidence
Level of corporation tax
Spare capacity
Level of competition
Price of capital
The rate of economic growth
Demand for exports
Definition of government spending
Government spending is spending on state provided goods and services including public goods and merit goods
Types of government spending
Transfer payments
Current spending
Capital spending
What is transfer payments
Payments made by the government to individuals or groups without expecting any goods or services in return for example state pensions disability allowances child benefits welfare Benefits
What’s the current spending
Spending on current goods and services for example wages of civil servants, teachers, nurses, doctors, armed and emergency services
What’s capital spending
On improvements to the public sector infrastructure for example new and improved schools, hospitals, roads, rail links such as HS2, airports, Olympic facilities
exports
Sold overseas inflow of demand / injection Into our circular flow of income and spending added to the aggregate demand
Import
A withdrawal of demand / leakage From the circular flow of income and spending
nettrade
Measures the value of exports minus The value of imports
When net exports are positive what does this mean
There is a trade surplus adding to aggregate demand
When net exports are negative what does this mean
That is a trade deficit reducing aggregate demand
What does the U K have
Trade deficit
Definition of saving
Represents a decision to postpone consumption the proportion of income saved is measured by household saving ratio which is the percentage of disposable income saved rather than spent
Factors that may affect the savings ratio
Advise in real interest rates on saving deposits
Expectations of future job losses
Rising consumer confidence
Restriction On the availability of credit
Taxes on savings
Higher debt levels such as a larger mortgage
Saving for retirement
whats the multiplier effect
happens where there is initial change in spending from consumers or businesses or the government( components of AD) leads to a larger and more widespread impact in economys total economy total output or income
what does the multiplier effect show
how chnages in spending create a ripple effect throughout the conimy generating additional rounds of economic activity
example of multiplier effect
when an individual increases their spending the recipients of that spending then have more income which they then spend on goods and services
how does the muliplier effect increase factor incomes
creates additional demand prompting businesses to create more supply and hire more workers resulting in higher factor incomes
definition of multiplier effect
final change in equilibrium national output resulting from an intial change in aggregate demand
whats a positive multiplier effect
when an intitial increase in an injection( gov spending, exports, investment) leads to a greater final increase in the level of real gdp
whats a negative multiplier effect
an initial decrease in an injection ( imports, saving, tax) leads to a greater final decrease in the level of real gdp
factors that effect the multiplier value
marginal propensity to consume
leakages
degree of spare capacity
time frame
explain marginal propensity to consume infulence in multiplier effect
a higher MPC leads to a larger multiplier effect as consumers tend to spend larger proportions of their income increasing the overall spending in the economy leading to further rounds of spending stimulating economic growth
explain the influence of leakages on the multiplier effect
leakages reduce the size of the multiplier. if people save a large proportion of their income or if a large portion of their spending is in the form of imports, taxes— multiplier effect= smaller
how does the degree of spare capacity influence the multiplier effect
if economy is operating close to its full potential with little spare capacity multiplier effect limited
If there is lots of spare capacity that means that there are unused resources and potential for increased production this can have a positive impact on the multiplier effect as it allows for more injections into the economy such as increased investment or government spending these can then lead to further economic activity and stimulate growth creating a multiplier effect
how does time frame influence the multiplier effect
short run- capacity constraints and restriction policys limit the size of the multiplier although in the long run adjustments in production capacity, investments and resource allocation lead to a larger multiplier
whats marginal propensity to consume and the formula
measure of proportion of an increase in come that a person or household is likely to spend on consumption
formula= change in consumption/ change in income
whats marginal propensity to save and formula
changes in household savings resulting in a change in household disposable income#
formula - change in total savings/ change in income
whats the accelorator effect
positive relationship between planned capitial investment and the rate of change of national income
what might happen in an industry where demand is rising quickly
respond initially by using exsiting capacity more intensively or running down stocks
if they expect high demand will be sustained they might increase capital spending to increase production
this all causes a positive accelorator effevt as a rise in demand for consumer goods and services will cause a bigger percentage chnage in demand for captital goods
what does the accelorator effect suggest
level of investment in an economy is related to the chnage in real GDP , a higher rate of economic growth causes more investment
if the rate of economic growth is slowing but the economy is still growing the level of investment might fall
overall conclude
an increase in the rate of real GDP in the economy encourages further investment which increases rate of GDP which encorages more investment etc etc
factors which influence the level of economic activity
employment- influences production and consumption
confidence- influences the level of spending and investment
events- natural disasters and celebrations e.g., christmas influence the level of consumer spending
other factors- interest rates
definition of economic activity
production, distribution and consumption of goods and services within an economy
what is the trade/business cycle
refers to stage of economic growth the economy is in it goes through booms and bursts
explain the cycle
real GDP increases when there are periods of economic growth- recovery stage
the boom is when economic growth is fast and could be inflationary or unsustainable
during reccessions the real GDP of the economy falls - negative economic growth - government might increase spending to try and stumulate the economy: welfare payments, cutting taxes etc increase government deficit
durring periods of economic growth governemnts may recieve more tax revenue since customers will be spending more VAT and earning more- income tax- govs spend less as economy doesnt need stimulating
