Aggregate Demand Flashcards

1
Q

what is aggregate demand?

A

Aggregate demand (AD) is the total level of spending in the economy at any given price

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2
Q

what is aggregate demand made up of?

A

consumption (C), investment (I), government spending (G) and net exports (X-M).

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3
Q

what does the AD curve show?

A

the relationship between price level and real GDP.

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4
Q

why is the AD curve downward sloping?

A

a rise in prices causes a fall in real GDP and there are four key reasons for this:

The income effect
Substitution effect
Real balance effect
Interest rate effects

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5
Q

what causes a movement along the AD curve?

A

a change in prices , caused by inflation or deflation.

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6
Q

what causes a shift of the AD curve?

A

A shift of the AD curve is caused by a change in any other variable

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7
Q

what do shifts to the left and right mean for AD curves?

A

a shift to the right represents an increase in AD and a shift to the left represents a fall in AD.

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8
Q

what is consumption?

A

Consumption is spending on consumer goods and services over a period of time.

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9
Q

what is disposable income?

A

Disposable income (Y) is the money consumers have left to spend , after taxes have been taken away and any state benefits have been added. This means that disposable income is affected by government taxation as well as wages.

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10
Q

what is the most important factor in determining consumption?

A

disposable income.

Those who are earning a large income will be able to spend much more than those on a minimum wage.

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11
Q

What is the average propensity to consume? (APC)

A

(APC) is the average amount spent on consumption out of total income. In an industrialised country, the APC for the economy is likely to be less than one as people save some of their earnings.

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12
Q

how to work out MPC?

A

MPC= change in consumption

change in income

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13
Q

how to work out APC?

A

APC= total consumption

total income

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14
Q

what is the relationship between savings and consumption?

A

An increase in consumption decreases savings so the same factors which affect consumption are those which affect savings- but in the opposite way. For example, a rise in confidence will decrease
savings

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15
Q

what are some influences on consumer spending?

A
interest rates
consumer confidence 
wealth effects
distribution of income 
tastes and attitudes
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16
Q

how do interest rates affect consumer spending?

A

Most major expenditures are bought on credit so therefore the interest rate will affect the cost of the good for consumers.

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17
Q

how does consumer confidence affect consumer spending?

A

One major factor that affects people’s spending is what they think will happen in the future. If people are confident about the future and expect pay rises, then they will continue or increase their spending.

18
Q

what is the wealth effect?

A

The wealth effect examines how a change in personal wealth influences consumer spending and economic growth. Rising wealth has a positive impact on consumer spending.
The wealth effect is experienced when
real house prices rise as owners now have more wealth so are more confident with spending as they know that if they go into financial difficulty they could simply borrow more against the house, since their house is worth more than their current mortgage.

19
Q

how does the wealth effect affect consumer spending?

A

Greater wealth will improve a consumer’s confidence and thus lead to greater spending.

20
Q

how does distribution of income affect consumer spending?

A

Those on high incomes tend to save a higher percentage of their income than those on low incomes and so a change in the distribution of
money in the economy will affect the level of consumption. If money is moved from the rich to the poor, consumption is likely to increase as the poor have a higher MPC.

21
Q

how do changes to taste and attitudes affect consumer spending?

A

there is a strong materialistic drive that encourages people to have the newest and the best and therefore spending can be very high, in some cases even above income. If people were less materialistic,
consumption would decrease.

22
Q

what is investment?

A

Investment is the addition of capital stock to the economy i.e. machines and factories used to produce other goods and services. It is only seen as investment if real products are created so buying a share in a company would be saving but buying new machinery is investment.

23
Q

what is the difference between gross investment and net investment?

A

Machinery depreciates (loses its value) over time as it wears out or gets used up. Gross investment is the amount of investment carried out and ignores the level of depreciation, whilst net investment is gross investment minus the value of depreciation.

24
Q

what are the influences on investment?

A
rate of economic growth
business expectation, confidence
demand for exports 
interest rates
government and regulations
access to credit 
retained profit
technological change
costs
25
Q

how does rate of economic growth influence investment?

A

: In a growing economy, there will be higher levels of
investment as businesses would be more confident about their investments and the higher demand would lead to a higher return rate on the investment.

26
Q

what is the accelerator theory?

A

The accelerator effect states that investment levels are related the rate of change of GDP. Thus an increase in the rate of economic growth will cause a correspondingly larger increase in the level of investment.

27
Q

how does business confidence affect investment?

A

When businesses are confident about the future and expect future growth, investment will increase as they want to prepare for the future. If they are fearful of the future, then they will not invest money in new ideas or machinery

28
Q

how does demand for exports affect investment?

A

If the world economy is booming, demand for exports is likely to increase and therefore exporting firms’ investment is likely to increase to cope with this extra demand. This will have a knock-on effect and encourage other firms to increase their investment.

29
Q

how do interest rates affect investment?

A

Most investment is done through borrowing. High interest rates mean that borrowing is more expensive, so a business needs to be more confident of good profits in order to cover the extra costs of borrowing. Other investment is done through retained profits or savings. A rise in interest rates increases the opportunity cost of a business using retained profits as they are able to get higher interest payments than before.

30
Q

how does government and regulations affect investment?

A

Governments can encourage
investment by their own policy decisions. Regulations also affects
investment as a highly regulated economy tends to see less investment as regulation
increases the cost and time taken to invest, such as planning regulations

31
Q

how does technological change affect investment?

A

Improvements in technology will improve or speed up
production which will increase the level of profitability, meaning the investment has a
better prospect of success. Change also means businesses need to invest to keep
up with the best technology

32
Q

how do costs affect investment?

A

A rise in the cost of any capital project increases the level of risk that you are taking and therefore leads to lower levels of investment. rises in the costs of making goods, such as the raw materials and wage, will decrease investment as it will reduce profitability. This means firms have less money to invest and decreases the rate of return on their investment.

33
Q

what is net trade?

A

total value of exported goods and services minus total value of imported products.

34
Q

how does real income affect net trade?

A

if real income is high, there will be increased imports as people demand more= net trade decreases.

However, if an increase in real income is due to export-led growth then net trade will increase. Therefore, the effect of changes in real incomes is dependent on many factors

35
Q

how do exchange rates affect net trade?

A

a strong pound makes imports cheap and exports dear as it costs foreigners more to buy pounds with their currency= imports will increase and net trade decrease

however, this depends on elasticity-If imports are price elastic, a rise in price will cause a large fall in
demand so the value of imports will fall.

36
Q

how does the state of the worlds economy affect net trade?

A

If the UK’s main export country is doing well, then UK
exports are likely to rise and so net trade is likely to rise. The effect of the state of the world economy is dependent on which countries are doing well and the trade relationship the UK has with them.

37
Q

how does the degree of protectionism affect net trade?

A

Protectionism is an attempt to prevent domestic
producers suffering from competition abroad, through tariffs, quotas and technical barriers.

high protectionism on UK exports in other countries= exports decrease as harder for UK firms to sell.

high protectionism on imports to UK =imports decrease.

if UK imposes protectionist measures, other countries are likely to retaliate and therefore exports
are likely to decrease

38
Q

what are non-price factors that affect net trade?

A

quality and design and marketing.

If UK goods are of a higher quality and design, exports will be high as foreign demand for UK goods will increase and imports will decrease as
people will buy the British goods instead of foreign goods.
This means net trade will increase.
If UK goods are well marketed, people will have a stronger desire to buy British goods so exports will increase and imports will decrease, so net trade will
increase.
Strong quality/design and marketing will mean that British exports are likely to be more inelastic.

39
Q

how can prices affect net trade?

A

High prices of UK goods will mean that the goods are less competitive compared to international goods since people make decisions partly based on price.
This means the volume of exports will decrease and the volume of imports will increase.

40
Q

how does the trade cycle influence gov expenditure?

A

Decisions over government expenditure may be made in order to manage AD, and therefore regulate the trade cycle. In a recession, the government
may increase spending in order to increase demand to reduce unemployment. Government spending also automatically rises during a recession as they have to
spend more on unemployment benefits. During booms, the government may decrease spending to decrease demand and reduce inflation.

41
Q

how does fiscal policy influence gov expenditure?

A

Some government spending is fixed from year to year, for example schools must be funded and pensions must be paid. However, governments can vary
what they spend each year, and this is set out in their budget. Fiscal policy is the decisions about government spending and taxes and it will depend on the priorities of the government. The level of government spending depends on what they lay out in
their fiscal policy.

42
Q

how does age distribution of the population influence gov spending?

A

An ageing population leads to increased
government expenditure on pensions, social care etc. whilst a young population leads to increased spending on education. The more dependents in the economy
(the young and old), the higher government spending tends to be.