Aggregate demand Flashcards
Define aggregate demand in words
total spending on goods and services produced in an economy during a period of time
What is the formula for aggregate demand?
AD = consumption (C) + investment (I) + government spending (G) + X (exports) - M (imports)
Define consumption
total planned household spending
Define disposable income
income that households have to devote to consumption and saving, taking into accounts payments of direct taxes and transfer payments
Define transfer payments
where transfers of goods or services are made between individuals and groups without production being undertaken, eg government providing social security benefits
Define average propensity to consume (apc)
proportion of income that households devote to consumption
Define marginal propensity to consume (mpc)
proportion of an increase in income that households would devote to consumption
Define marginal propensity to save (mps)
proportion of an increase in income that households would devote to saving
What did Keynes suggest was the most important determinant of consumption?
disposable income
What was Friedman’s permanent income hypothesis?
That consumers make decisions on consumption based on a notion of their permanent, or normal, income levels, eg what they expect to receive over next 5-10 years
What was Modigliani’s life-cycle hypothesis?
that households smooth consumption over their lifetimes on basis of expected lifetime incomes - so tend to borrow when young against future income, pay off debts and save in middle age, in preparation for consumption in retirement
Define wealth effects
where changes in household
wealth induce changes in consumer expenditure
What effect would an increase in interest rates generally have on consumption?
reduction, as will encourage saving and discourage borrowing
Define investment
expenditure undertaken by forms om capital goods
Define gross investment
net investment plus depreciation
Define net investment
investment net of replacement of existing capital (depreciation)
Define depreciation (of capital equipment)
fall in value of capital goods due to wear and tear
What are the main influences on investment expenditure by firms?
- expected future demand
- government incentives
- interest rate
What are the main influences on exports?
- income / economic growth in other countries
- exchange rate
- other countries’ tariffs or restrictions on imports
- relative prices to prices in rest of world
What does the *aggregate demand curve *show?
relationship between aggregate demand overall price level
What is the real balance effect?
effect by which an increase in average price level reduces purchasing power and thus the quantity of real output demanded
Why does the aggregate demand curve slope down?
When prices low:
* purchasing power of income and wealth is high (real balance effect)
* interest rates tend to be low (interest rate effect)
* competitiveness of UK good increases (trade effect)
