Aggregate Demand Flashcards
What is Aggregate Demand (AD)?
The total planned expenditure in an economy
AD is calculated using the formula: AD = C + I + G + (X - M), where C = consumption, I = investment, G = government spending, X = exports, and M = imports.
What does the AD curve represent?
The relationship between the price level and the quantity of goods and services demanded
The AD curve slopes downwards to the right.
What is the wealth effect?
When prices fall, consumers feel better off as their income can buy more
This effect contributes to movements along the AD curve.
What are the main determinants of Aggregate Demand?
- Consumption
- Investment
- Government Spending
- Exports - Imports
Each of these factors can shift the AD curve.
What happens to exports when the price level drops?
Net exports increase, leading to an increase in aggregate demand
This occurs due to lower interest rates and a depreciating real exchange rate.
How does the interest rate affect Aggregate Demand?
Lower interest rates usually lead to higher aggregate demand
This is because lower rates encourage borrowing and spending.
Fill in the blank: The formula for Aggregate Demand is AD = _______
C + I + G + (X - M)
C = consumption, I = investment, G = government spending, X = exports, M = imports.
True or False: Government spending is affected by the price level.
False
Government spending remains constant regardless of price level changes.
What percentage of GDP is accounted for by personal consumption?
60%
Personal consumption is a major component of aggregate demand.
What is the impact of the savings ratio on Aggregate Demand?
A higher savings ratio typically leads to lower aggregate demand
This is because less disposable income is available for consumption.
What is the shape of the AD curve?
Downwards to the right
This indicates an inverse relationship between price level and quantity demanded.
What is consumption?
The spending by households on goods and services
What % of GDP does consumption account for?
60%
What factors will change the level of consumption?
Level of income, employment, consumer confidence, future price changes, job security.
What does the personal savings ratio measure?
The actual or realised saving of the personal sector as a ratio of total personal sector disposable income.
What is the personal saving ratio equation?
Realised or actual personal saving / personal disposable income
What does the household savings ratio measure?
The households realised saving as a ratio of their disposable income.
What is investment?
The spending on machinery (capital) , buildings and improving the skills of the workforce (human capital)
What factors affect investment?
Borrowing costs, business confidence, productivity of capital, changes in demand, stock market, employment levels.
What is government spending?
Mainly spending by the government on public and merit goods.
*gov spending has fallen over past 50 years
Examples of privatised businesses.
-British steel
-British telecom
-British gas
What do the government spend money on?
-Health
-Education
-Defence
-Social security
-Transport
What is Net exports?
Exports minus imports
What is the effect on AD if other economies are in a recession?
They won’t be able to afford the goods/services we produce and therefore AD would shift to the left. AD decreases.
What factors affect the demand for imports and exports?
Exchange rates, Inflation, trade policies, economic states of other economies.
What is the savings ratio?
The % of the disposable income that is saved rather then spent. Higher the savings ratio the lower consumption will be and the Therefore investment.
How does the real interest rate affect the savings ratio?
This is the nominal interest rate adjusted for inflation, a positive real interest rate makes saving attractive.
How does price expectations affect the savings ratio?
Positive expectations would tend to reduce savings and increase spending.
If people think the prices falling they save now.
How does unemployment affect the savings ratio?
High unemployment might induce people to save more and hence consume less.
How does consumer confidence affect the savings ratio?
Less prone to save if there is high confidence. Low confidence means higher savings ratio.
How does consumer confidence affect the savings ratio?
Less prone to save if there is high confidence. Low confidence means higher savings ratio.
How does tax on savings affect the savings ratio?
Higher tax on savings means lower savings ratio as saving is more expensive. So less people save.
Why is saving important?
-Saving facilitates lending
-Helps people achieve financial security
-Allows for future financial goals e.g buying a house
-Backup in a recession
-Bank liquidity
-Capital investment funding
-Key source of retirement income
What is the marginal propensity to consume (MPC)?
Proportion of Income that you spend.
What is replacement investment?
Maintains size of existing capital stock by replacing worn out machinery.
What is net investment?
Adds to capital stock therefore increases productive potential.
What is the accelerator effect?
When an increase in national income results in a proportionately larger rise in investment.
What is the Demand for capital goods being driven by?
The demand for the products that the firm is supplying to the market. This gives rise to the accelerator effect.
What is a budget deficit?
When government spending exceeds tax revenue
What is a budget deficit?
When government spending exceeds tax revenue
What is a budget surplus?
When tax revenue exceeds government spending.
