Aggregate Demand Flashcards
Aggregate demand define
The total demand for a country’s goods and services at a given price level and in a given time period.
Price level define
The average of each other prices of as the products produced in an economy.
AD equation
AD = C + I + G ( X - M )
Real GDP define
The country’s output measured in constant prices as so adjusted for inflation.
Consumer expenditure define
Spending by households on domestic consumer products
Investment definition
Business and government spending on capital goods.
Government spending define
Current expenditure by the central government and local government on goods and services e.g. Spending on teachers’ pay, nurses, etc.
Exports define
The value of goods and services sold abroad.
Imports define
The value of goods and services bought from abroad
Net exports define
The value of exports minus the value of important.
What does the AD curve show?
AD curve shows the relationship et week aggregate demand and the general price level in the economy, that is, as the general price level rises, AD falls, ceteris paribus. As the general price level fall, AD rises ceteris paribus. There is an inverse relationship between the price level and AD.
Why is there an inverse relationship between the general price level in the economy and aggregate demand?
- real money balances effect
- interest rate effect
Real money balances effect
The lower the average domestic price level, the more a fine money income / stock of savings will buy. Therefore, consumption / AD is higher.
Interest rate effect
If in the UK the general price level falls, this causes a decrease in the demand for money and a consequential fall in interest eyes with an expansionary effect in the entire economy, this is reflected in an increase in AD.
Effect of a rise in the general domestic price level on AD.
Increase price
Decrease in real output
(Due to increase in average domestic price, e.g. Did to high interest rates).
10% increase in average income may not result in 10% increase in consumer expenditure
Increase by 10% if the marginal propensity to consume is less than 1. They do not spend as they are spending. MPS higher than 0.
Determinants of consumption
- Real disposable income
- availability of credit
- household wealth
- interest rates
- consumer confidence
- the distribution of income and marginal propensity to consume
Real disposable income
An increase in real disposable income will lead to an increase in consumer expenditure and vice versa.
Consumer spending rises because the demand for all normal goods rises as incomes rise.
Household wealth
Higher wealth, e.g. Savings, shares, etc. Tends to lead to higher spending. This is because savings can be spent and more can be borrow against the value of other assets, such as a house.
Define income
A flow.
E.g. Dividends, wages, etc.
Wealth
Is a stock/ asset
E.g. Land, jewellery, property.
Interest rates
Fall in interest rates can lead to an increase in consumer spending and an increase in interest rates can lead to a fall in consumer spending. Because:
- Discretionary income. Mortgages rises if interest rates are cut, because they pay less.
- If interest rates fall the cost of credit falls leading to an increase in borrowing and credit spending.
- The incentive to save is reduced if interest rates fall. Vice versa.
The availability of credit
Even if the Bank of England cigs the base rage of interest, if banks are unwilling to lend (e.g. Credit crunch) consumers will not be able to get access to credit to increase spending.
Consumer confidence
Low unemployment and greater job security or an increase in household wealth will make people more confident in their future.
The distribution of income and marginal propensity to consume.
People on higher incomes are likely to save and those on lower incomes who are more likely to spend a higher proportion of their income and therefore low income groups have a higher MPC.
Determinants of investment expenditure
- interest rates
- business confidence / expectations
- increases in the growth rate of real GDP
- corporate tax rates
- current capacity utilisation rates
- price of capital equipment
- advances in technology
Investment expenditure
Interest rates
Lower unrest rates may lead to higher investment expenditure by firms and higher interest rates may lead to lower investment expenditure because:
When interest rates are raised, the cost of borrowing to invest has increased, therefore firms borrow less for the purpose of investment.
The rate of return on retained profits held in interest bearing accounts will increase, this means that firms are less likely to use retained profit for investment and more likely to save.
Business confidence / expectations
If businesses are confidence about future levels of demand economic growth, future interest rates and expect high real rate of return on investment projects / investment should rise.
Investment determinants
Increases in the growth of real GDP
Higher real growth rates in the previous year may lead to an acceleration in the rate of investment in the following year, so that firms can expand capacity to meet higher levels of demand arising from higher income.
Determinants of investment
Corporate tax rates
A reduction in corporate faces increase firm’s post tax profits. Firms can tear in more profit and so fun increased investment out of higher retained profits.
Current capacity utilisation rates
If firms are operating at below full capacity, they are less likely to I rag, however, if they are writing at full capacity they may have to invest in order to increase output further.
Price of capital equipment
Investment determinants
If the price of capital equipment falls, a for is more willing and able to buy it and so investment would likely increase.
Investment determinants
Advances in technology
Advances in technology will not only increase productive capacity but might encourage firms to accelerate the Faye of investment in order to remain competitive as rivals innovate the new technology.
Determinants of government spending
Political factors
Cyclical factors
War
Determinants of government
Political factors
Political hyperopia: government spending may be more likely to decrease shortly after an election.
Political myopia: government spending may increase in the run-up to an election.
Cyclical factors
Government spending
During a recession government may increase it’s spending. E.g. On education or health care or other public services by creating more jobs in the public sector this helps to increase AD, employment, etc.
During periods of rising inflation the government may cut it’s spending to reduce upside pressure on prices.
Government determinants
War
War time government expenditure tends to be higher than peace time e.g. Afghanistan
Determinants of net exports
International competitiveness of Uk goods
Exchange rates
Real disposable income abroad
The domestic rate of inflation / price level
The extent to which barkers to trade exist in the markets of our trading partners.
Exports increase
AD increases
If imports increase
AD decreases
If exports decrease
AD decreases
If imports decrease:
AD will increase
Net exports determinants
International competitiveness of UK goods
If uk goods are price competitive and of the right quality / design, UK exports may rise and imports may fall, is so net exports rise. This will lead to an increase in AD.
Determinants of net exports
Exchange rates
An increase in the strength of the pound exchange rate leads to an increase the relative price of Uk exports and a fall in the relative price of imports to the UK. Therefore, exports would fall an imports would rise.
Exchange rate calculations
X - away from home
Divide - back home
Stronger pound
Price imports ⬇️
Price exports ⬆️
Demand for imports ⬆️
Demand for exports ⬇️
AD ⬇️
Weaker pound
Price of imports ⬆️
Price of exports ⬇️
Demand for imports ⬇️
Demand for exports ⬆️
AD ⬆️
Real disposable income abroad
A rise in disposable income abroad may lead to an increase in demand for Uk goods and a fall in demand if disposable income abroad falls.
The domestic rate of inflation / price level
UK inflation ⬆️ Other economies ➡️ UK prices ⬆️ UK competitiveness ⬇️ Exports ⬇️ Imports ⬆️ Net ⬇️ AD ⬇️
The extent to which barriers to trade exist in the markets of our trading partners.
If there are barriers to trade e.g. Tariffs. It will reduce UK exports.
Aggregate define
Overall / sum of multiple parts
