Aggregate Demand Flashcards
What is AD?
Aggregate Demand- total planned expenditure of 🚘/🧹 produced in a country
What is the AD formula?
AD = C + I + G + (X-M) = GDP
How does AD respond to a change in price?
When price ⬇️, AD expands along AD curve
When price ⬆️, AD contracts along AD curve
Why is the AD curve downward sloping?
1) At ⬆️ price levels, interest rates ⬆️ to ⬇️ demand (as initial ⬆️ price caused by inflation from ⬆️ demand)-> ⬇️ in investment as loans ⬆️ expansive & … AD ⬇️
2) ⬇️ domestic prices = ⬆️ international competition … ⬆️ exports & ⬇️ imports … net exports ⬆️ … AD ⬆️
What are the components of the AD formula?
C- consumption I- investment G- government spending X- exports M- imports
What is consumption?
Spending by 🏠holds on 🚘/🧹
How much does consumption make up of AD?
Main component of AD (60%)
What is investment?
Increase in capital stock (machines etc)-> ⬆️ 💵 in the future
How much does investment make up of AD?
Makes up 10-15% of AD (dependent on whether gross or net investment being considered)
What is unique about the relationship between AD and investment?
Investment effects AD AND AD effects investment
What is gross investment?
Gross investment- total investment before depreciation of capital assets considered (capital ⬇️ value as it wears out or becomes ⬇️ efficient- some made totally redundant when new production methods introduced)
What is net investment?
Net investment- takes into account the ⬇️ of capital assets
When is net investment more useful?
⬆️ useful when looking at productivity of economy & production potential
Which factors affect spending/consumption?
- ⬆️ income after tax = ⬆️ disposable income-> ⬆️ spending & ⬆️ saving
- Consumer confidence in job security & future income 💵 prospects
- Interest rates
- Housing market- ⬆️ 🏠 prices-> ⬆️ equity available to be extracted from 🏠 (wealth effect)
Which factors affect investment?
1) Economic growth- ⬆️ confidence in future sales
2) Business expectations- ⬆️ confidence in future sales
3) What main competitors are doing
4) Government incentives & regulations
5) Interest rates- ⬆️ interest rates = ⬆️ cost of borrowing
6) Demand for exports- ⬇️ exchange rate = ⬆️ demand for exports-> ⬆️ investment
7) Access to credit- how keen banks are to lend 💵- conditions applied to loans etc
What are animal spirits?
Animal spirits- forces that make markets move in large booms or busts cause irrational humans buy & sell impulsively rather than rationally to avoid losses & make profit
Who came up with animal spirits?
Keynes
What do animal spirits cause people to do and what are the consequences of these actions?
Animal spirits-> buy when prices ⬆️ (make profit) & sell when prices ⬇️ (avoid loss)
Explains volatility in asset prices- speculative buying exaggerates trends in business 🚲
What is government expenditure?
All spending in economy
How much does government expenditure make up of AD?
Makes up 25% of AD
What is a budget/fiscal deficit?
Budget/Fiscal deficit- ⬆️ spending than tax revenue- dome during recession/slow down to ⬆️ AD
What is a budget/fiscal surplus?
Budget/Deficit surplus- ⬇️ spending than tax revenue- done during boom to ⬇️ AD (prevent ⬆️ inflation)
Which factors affect government expenditure?
1) Trade cycle 🚲 (pattern of economic growth- changes from booms to recessions etc)- in a boom there is ⬆️ economic growth & … G ⬇️ as ⬇️ demand for Jobseeker’s allowance & other benefits etc
2) National debt (accumulation of budget deficits over the years)- interest payments need to payed on debt & … ⬆️ spending-> cost for further generations
What is the Keynesian view on expansionary fiscal policy?
Keynes- fiscal policy powerful tool to shift AD
What is the classical view on expansionary fiscal policy?
Classical- overspending has same effect as printing ⬆️ 💵 = purely inflationary
What is net trade/net exports (X-M)?
Exports- injection into circular flow of income (💵 inflows into domestic flow of income)
MINUS —
Imports- withdrawal (outflow of 💵)
Which factors affect net trade?
1) Level of real income- ability for consumers both domestically (imports) & foreign (exports) to buy 🚘/🧹
2) Exchange rate- ⬆️-> imports cheaper & exports expensive-> ⬆️ imports & ⬇️ exports … strong 💴 worsens net exports- vice versa for ⬇️ BUT dependent on demand elasticity- if inelastic e.g. for⛽️ then exchange rate ✖️ affect net trade
3) Global economy- recession in 1 country means it buys ⬇️ 🚘 from another & export ⬆️- ALSO inflation in 1 country makes its 🚘 ⬇️ competitive as ⬆️ expensive
4) Protectionism- trade restrictions placed of foreign firms
