aggregate demand Flashcards
graph of AD
downwards sloping demand curve
ad equation meaning
aggregate demand = consumption + investment+ government spending + (export - imports)
why does the AD curve slope down
- PL rising - interest rate usually rises as well - to maintain real rate of interest which otherwise would be distorted by inflation
- higher wages demanded by labour force - real wages fall as PL increases cet par = less purchasing power
- as PL higher, price of exports increases - less people likely to buy X - AD falls
what shifts AD?
changes in injections (I, X, G) or leakages (T, M, S)
YPD meaning
YPD - personal disposable income: gross income - direct tax = net income
net income - indirect tax = personal disposable income
= consumption + savings
keynesian consumption function
keynes argued that consumption is a function of personal disposable income
c=f(Ypd)
graph showing c=Ypd upwards sloping 45 degrees to Ypd (x axis) and C(y axis)
extra line y=a+bYpd
a = necessities
b = gradient
gradient of keynesian consumption function
b = marginal propensity to consume - constant according to keynes
marginal propensity to save - MPS
percentage likely for comsumers to spend vs save
mpc + mps = 1
calculated by change in saving/ change in income
marginal propensity to consume - MPC
percentage likely for comsumers to spend vs save
shown by gradient on y = a + bYpd
APS and APC
average propensity to save and average propensity to spend
apc + aps = 1
difference between marginal and average propensities
marginal - needs 2 numbers to measure a change
average - any point in time, one number needed, just total x/total y
low income apc/aps
low income people - do not have enough to fund necessities (a) so aps is negative and apc is over 1
called ‘dissaving’
high income apc/aps
apc significanly below 1 for high income earners (apc>mpc) so they are more likley to save
recent UK trends in consumption
- Covid - fall in consumption but compensated after covid by all the savings in covid, traveling
- as inflation rose, consumption fell as real incomes fell
- rising interest rates meant cost of money riased so people with loans lower Ypd so lower C
- high UE levels - lower C
- falling house prices - negative wealth effect - less consumption because less confidence
why do people save
- uncertainty - short tern uncertainty funds as precaution
- smooth consumption - save for the future and retirement to be able to keep consuming and maintianing lifestyle
factors influencing saving ratio
- wealth - higher wealth effect, less likley to save (example - houses, shares)
- interest rates - higher rates, higher reward for saving so more saving
- demographic - middle aged people likely to save more
- inflation - less likely to save if rising inflation - have lower real income
- culture - some cultures have different propensity to save
- uncertainty - expectations on economic outlook
- constraints - if they have to spend on something
what cultures have highest and lowest propensities to save?
highest - greece, lithuania
lowest - netherlands, portugal
investment definition
spending by firms on capital goods
what are capital goods
anything that can be used more than once and is manufactured
business performance relationship to investment
business performance in the future is a function of the investment done today
UK investment
too low compared to other developed countries
capital consumption
money spent to replace capital
Gross investment equations
Gross I = Net investment + capital consumption = total spending on I
Gross I = GDFCF (gross domestic fixed capital formation)
Net investment
money spent on new capital
revenue costs
gross profit - corporation tax = net profit
net profit = dividends + retained profit
retained profit is what goes into investment
why do firms invest
- decreasing average CoP
- so they can lower prices and increase competition
- increase output - increasing market share and pricing power
- all lead to higher profit
(neoclassical ec. theory: firms aim to maximise profit)
what affects if a firm invests
- profit
- confidence/expectations
- type of firm - labour v capital
- interest rates if loans needed
- competition
- access to finance
MEC in investment and graph
MEC = marginal efficiency of capital
graph is downwards sloping straight line - r = interest rates = y, quantity = x
as interest rates increase, costs of borrowing are hgher so quantity falls
what are MEC curves affected by
expectations / expectations of profitability of revenue function
what is debt interest
money paid back by the government to people who are owed money
what % of GDP in Uk is GS?
45%
% of UK GDP consumtpion
62%
what is a budget deficit
when GS>TR
what determines government spending
- revenue / budget
- market failure that needs intervention
- quality of public services
- state of the economy
- inflation
- demographic
- government debt and interest on spending
- external crises
- political decisions
- bond - interest rates
- wages - people employed by governmentq
3 parts of GDP
capital spending - government investment
current spending - day to day spending
transfer payments - payments not going to get back such as welfare benefits
UK exports and imports
UK is net importer
X<M so
examples of UK exports: chemicals, oil, automobiles, machinery
examples of UK imports: mineral fuels, electronic equipment, pharmaceuticals, plastics
determinants of quantity of X and M
- exchange rate
- relative prices
- quality of goods
- protectionism
- interest rates
- incomes
- location
multiplier formula
K (multiplier) = 1/leakages
=1/mpw
= 1/(mpt+mps+mpm)
UK economists think it is between 1 and 2
most efficient injection
investment spending
LRAS shift with multitplier
will only shift when effects of injections happen
