Aggregate Demand and Aggregate Supply Flashcards
What is aggregate demand?
Aggregate demand is the total expenditure on domestically produced goods and services by the four broad groups in an economy. It consists of 4 elements: consumption (C), investment (I), government expenditure (G) and net exports (X - M).
What is the formula for calculating AD?
AD = C + I + G + (X - M)
What is investment expenditure (I) ?
It is the spending by firms on capital goods such as factories, machinery, inventory stock of raw materials and unsold goods.
What is consumption expenditure (C) ?
It is the spending by households on goods and services, with the exception of purchases of new housing.
What is government expenditure (G) ?
It is the spending by government on consumer goods and services as well as investment goods (i.e. salaries and wages to government employees etc).
What is exports earnings (X) ?
It is the spending by foreigners on domestically produced goods and services.
What is import expenditure (M) ?
It is the spending by local households, firms and government on foreign produced goods and services.
How does C affect the AD curve?
Borrowers:
As the interest rate decreases, the cost of borrowing decreases. Hence, it is cheaper to buy big ticket items such as cars. Households are also encouraged to spend on credit. Thus, consumer expenditure increases, and the AD curve shifts to the right (and vice versa).
Savers:
As the interest rate decreases, savers get a lower return on savings. Hence, there is less incentive to save. There is also a low opportunity cost to consume as they lose less interest earnings. Hence, consumer expenditure increases as the AD curve shifts to the right (and vice versa).
How does I shift the AD curve?
- Interest rate (cost of borrowing)
- Cost of capital goods
- Business expectations
- Government policies
- Changes in technology
- Political stability
How does G shift the AD curve?
- Objectives of the government (such as to reduce government debt)
- State of the economy
- when an economy is in a recession, AD components such as C and I fall due to pessimism
- to prevent further falls in AD, the government usually increases govt spending
How does X shift the AD curve?
- Level of national income of major trading partners
-When foreigners earn more, they are able to consume more goods
- these goods are exported from SG, and hence export earnings rise - Relative inflation rates
- if inflation rate of a country is higher than its trading partners, it will make its exports relatively more expensive - Exchange rates
- Foreign protection
How does M shift the AD curve?
- Income level of SG
- Relative inflation rates
- Exchange rates
- Local protection
What is aggregate supply?
It measures the volume of goods and services produced within an economy at a given price level.
What are the factors affecting the AS curve?
- Changes in costs of production in the economy
- Changes to producer taxes and subsidies
- Quantity of factors of production
- Improvements in the quality of factors of production / technology
- Investment in infrastructure such as roads, telecommunications, hospitals and schools
How do changes in costs of production in the economy affect the AS curve?
- Increases in labour, raw materials and component costs can increase the overall production costs for firms
- The increase in production costs affect the firms
- A rise in cost of production will cause firms to require higher prices to produce the same amount of goods as before
- This would cause the AS curve to shift upwards assuming ceteris paribus
