Aggregate demand Flashcards
What does aggregate demand measure
Total spending on UK output
What is the formula for aggregate demand
C+I+G+(X-M)
How does changes in the GPL (measured by CPI) affect the AD curve
- Increase in GPL causes contraction along AD curve
- Fall in GPL causes expansion along AD curve
What causes a shift in AD
Changes in any of the components of AD at a given price causing changes in output
What is the most influential component of AD that leads to the largest change in GDP
Consumption
How does an increase in household income impact consumption
- Increases willingness and able to spend, increases consumption
- Only looks at current income e.g. if income may fall in the future, consumption may stay the same
How does a decrease in income tax or national insurance impact consumption
- Disposable income = income - (tax + national insurance) so increased disposable income increases consumption
How do falling interest rates impact consumption
-Reduces incentive to save and increases incentive to borrow (talk about opportunity cost of saving)
- Increased borrowing causes increase consumption
How does rising job security and household confidence impact consumption
Increased confidence about the future causes a decrease in precautionary saving, increases consumption
What is the positive wealth effect and how does it impact consumption
Positive wealth effect is when value of assets increase, which increases consumer confidence as assets can be sold for a profit, which can be spent, increasing consumption
How does easier credit availability from banks impact consumption
Easier to borrow money so more borrowing so more consumption
(opposite of a credit crunch)
What is the relationship between risk and consumption
Consumption puts finances at risk so people are more likely to consume when their confidence is high
What is the savings ratio
% of disposable income that is saved
What factors affect the savings ratio
- Levels of wealth
- Interest rates
- Job security and confidence
- Willingness to accumulate debt
What is investment
Spending on capital equipment by firms
Why is investment the most volatile component of AD (can change from 25% to -25% very quickly)
- investment is a long term decision and the economic future is very uncertain
- Firms can delay investment projects (whereas they can’t delay paying wages)
so investment is very flexible - it is cheaper to invest if firms do it in bulk so they invest a lot or not at all, it doesn’t grow constantly
What factors determine the level of investment
- Future economic growth
- Business profitability
- Levels of interest rates
- Government policy
Explain why future economic growth impacts investment
- If economic growth occurs, demand increases and output from firms needs to match the demand
- If demand increases to full capacity, firms need to invest to increase full capacity to be able to meet demand
- This relationship is called the accelerator effect.
Explain how business profitability impacts investment
An increase in business profits makes firms more willing and able to invest
Explain how the level of interest rates impacts investment
- The investment will be less profitable if the costs of borrowing are higher
- Alternatively, firms may earn more interest on retained profits in a bank account, increasing profits
How does government policy impact investment
- Taxes or subsidies impacts the net profit of firms, impacting willingness and ability to invest
Why does a fall in exchange rates impact AD
Increases exports and decreases imports
What is a fiscal policy
Type of government policy involving government spending and tax policies to influence AD
What is a monetary policy
Type of government policy involving controlling availability of credit to impact AD
What is the multiplier effect and what causes it
- When an initial injection/leakage into/out of the circular flow causes a greater final increase/decrease in national income
- caused because one agents spending is another agents income
What is the formula for the multiplier effect
1/(1-Marginal Propensity to Consume)
Also
Final injection/ initial injection
