aggregate demand and aggregate supply analysis chapter 17 Flashcards
aggregate demand (AD)
the total demand for an economy’s goods and services a given price level in a given time period
what does aggregate demand describe
the total spending of consumers (households), firms and the government plus foreigners’ spending on the country’s exports minus spending by the country’s consumers, firms and government on imports.
factors of aggregate demand
consumer expenditure
investment
government spending
net exports
factor of AD:consumer expenditure (consumer spending or consumption)
spending by households and services to satisfy current wants
main influence of aggregate demand
the main influence on consumer expenditure is the level of disposable income. when the income rises, total spending also usually rises, with rich people spending more than poor people. consumer expenditure can exceed income (dissaving)
dissaving
consumer expenditure exceeds income, with people or countries drawing on past savings, or borrowing
saving
income minus consumption
factors influencing consumer expenditure
disposable income
distribution of income
the rate of interest
the availability of credit
expectations
wealth.
how does income being equally distributed influence consumer expenditure
when rich people lose income they are unlikely to cut back on their spending significantly, while people on low incomes who gain more income will spend most of the extra. consumer expenditure is likely to rise.
how interest rates influence consumer expenditure
Households will also usually spend more when interest rates are low. This is because the return from saving will be reduced, buying goods on credit will be cheaper and households that have borrowed before to buy a house will have more money to spend
how does availability of credit influences consumer expenditure
If it becomes easier to obtain loans, total spending is likely to increase. However, people are unlikely to borrow and to increase their spending if they are pessimistic about the future.
how do expectations influence consumer expenditure
Indeed, expectations about future economic prospects are thought to be a major influence on consumer expenditure. When people become more optimistic that their future jobs are secure and that their incomes will rise, they are likely to increase their spending.
how does wealth influence consumer expenditure
people spend more as the value of their assets rise. this means that consumers feel more financially secure and confident about their wealth when their homes or investment portfolios increase in value
factors influencing aggregate demand: investment
investment is the private sector spending on capital goods such as factories and machinery
what influences the amount of private sector investment undertaken
influenced by changes in consumer demand, the rate of interest, technology, the cost of capital goods, expectations and government policy.
how does changes in demand influence investment
If consumer demand rises, firms are likely to want to buy more capital equipment to expand their capacity.
how does changes in rate of interest influence investment
a fall in the rate of interest is likely to stimulate a rise in investment. The cost of investment will fall. Firms that borrow to buy capital goods will find it cheaper and firms that use retained profits will find that the opportunity cost of investment will fall. Firms will also expect higher sales as lower interest rates will raise consumer demand.
how does technology influence investment
advances in technology will raise productivity of capital goods and so will probably stimulate more investment
how does the cost of goods influence investment
a fall in the price of capital equipment and/or cost of installation of capital goods is likely to raise investment.
how does expectations influence investment
When firms are optimistic that economic conditions are improving and demand for their products will rise, they will be encouraged to raise their investment.
how does government policy influence investment
Governments can also seek to increase private sector investment by cutting corporate tax (the tax on company profits) and by providing investment subsidies.
what does government investment help show
Government investment is usually included in the government spending component. This allows the contribution of the government sector and the difference between aggregate demand in a closed economy without a government sector and one with a government sector to be clearly seen.
factors that influence aggregate demand: government spending
the total of local and national government expenditure on goods and service. includes expenditure on providing merit goods.
factors that influence aggregate demand: government spending
the total of local and national government expenditure on goods and service. includes expenditure on providing merit goods
factors that influence government spending
government policy
tax revenue
demographic changes.
how does government policy influence government policy
If a government wants to raise economic activity, it may decide to raise its spending.
how does tax revenue influence tax revenue
Higher government tax revenue will enable a spend more, without needing to borrow.
how does demographic (population) changes influence government policy
Pressure for a rise in government spending may come from an increase in the government to number of children (education) and/or an increase in the number of elderly people (healthcare).
factors that influence AD: Net exports
exports minus imports.
exchange rate
the price of one currency in terms of another currency.
factors that influence net exports
country’s GDP
other countries’ GDPs
the relative price and quality
competitiveness of the country’s products
its exchange rate.
how does a country’s GDP influence net exports
When a country’s GDP rises, demand for imports usually increases. Some products may also be diverted from the export market to the domestic market.
how does the other country’s GDP influence net exports
When incomes rise abroad, demand for the country’s exports is likely to increase.
how does the relative price and quality influence net exports
A rise in exports may also result from an improvement in the competitiveness of the country’s products,
how does exchange rates influence net exports
The level of the exchange rate can be a key influence on net exports. If the exchange rate falls in value, the country’s exports will become cheaper and imports will become more expensive. If demand for exports and imports is elastic, export revenue will rise while import expenditure will fall, causing net exports to fall.
what does the AD curve show
shows the different quantities of total demand for the economy’s products at different prices.
what happens to AD when there is a rise in price
a rise in price will cause a contraction in aggregate demand
what happens to AD when there is a fall in price
a fall in price will result in an extension in aggregate demand
difference between the relationship between AD and price and the demand curve of a individual product
A demand curve for a product shows the relationship between a change in the relative price of a product and the quantity demanded. The price of the product is changing but it is assumed that the prices of other products have not changed. More of the product is purchased when the price falls, in part because people change from rival products. In contrast, in the case of the AD curve, the prices of most products are changing in the same direction.
how does the wealth effect influence price levels
A rise in the price level will reduce the amount of goods and services that people’s wealth can buy. The purchasing power of savings held in the form of bank accounts and other financial assets will fall.
how does international effect influence price levels
A rise in the price level will reduce demand for net exports as exports will become less price competitive while imports will become more price competitive.
how does interest rate effect influence price levels
A rise in the price level will increase demand for money to pay the higher prices. This, in turn, will increase the interest rate. A higher interest rate usually results in a reduction in consumption and investment.
shift in the AD curve
While a change in the price level causes a movement along the AD curve, if any non-price level influence causes aggregate demand to change, then the whole AD curve will shift.
What does it mean by the AD curve shifting to the left
A shift to the left indicates a decrease in aggregate demand
what does it mean by the AD curve shifting to the right
a shift to the right shows an increase in aggregate demand
aggregate supply (AS)
the total output (real GDP) that producers in an economy are willing and able to supply at a given price level in a given time period.
short-run aggregate supply (SRAS)
the total output of an economy that will be supplied when there has not been enough time for the prices of factors of production to change.
long-run aggregate supply (LRAS)
the total output a country supplied in the period when prices of factors of production have fully adjusted.
how does profit effect affect the positive relationship between rising price levels and supply of more goods and services
As the price level (that is, the price of goods and services) increases, the prices of factors of production such as wages do not change thus the gap between output and input prices widens and the amount of profit increases.
how does cost effect affect the positive relationship between rising price levels and supply of more goods and services
It is assumed that wage rates, raw material costs and other input prices remain unchanged along an individual SRAS curve. However, average costs may rise as output increases. This is to cover any extra costs that may be involved in producing a higher output, producers will require higher prices.
how does misinterpretation effect affect the positive relationship between rising price levels and supply of more goods and services
Producers may confuse changes in the price level with changes in relative prices. They may think that a rise in the price they receive for their products indicates that their own product is becoming more popular. As a result, they may be encouraged to produce more.
short run aggregate supply curve
it slopes up from left to right
how does a change in the price of factors of production cause a shift in the SRAS curve
A rise in wage rates, not matched by an increase in labour productivity, and raw material costs will cause a decrease in SRAS, shifting the curve to the left
how does a change in taxes on firms cause a shift in the SRAS curve
a reduction in corporation tax or indirect taxes will cause an increase in SRAS
how does a change in factor productivity/quality of resources
A rise in labour productivity and/or capital productivity will cause an increase in aggregate supply both in the short and long run.
how does a change in the quantity of resources
In the short run the supply of inputs may be influenced by supply-side sucks including natural disasters. These shocks may not have a significant impact on p in the long run. productive
what increases SRAS
the factors that will cause an increase in the quantity of resources in the long run will also increase SRAS
average cost
the cost per unit of outpu
supply side shocks
large and unexpected changes in short run aggregate supply
Keynesians
people who agree with the view of the economist John Maynard Keyes that government intervention is needed to achieve full employment
what does long run aggregate supply curve show
it shows the relationship between real GDP and changes in the price level when there has been time for input prices to adjust to changes in aggregate demand
how do Keynesians represent LRAS curve
they are represented as perfectly elastic low rates of output, then upward sloping over a range of output and finally perfectly inelastic
why do Keynesians represent LRAS curve as perfectly elastic low rates of output
to emphasize their view that, in the long run, an economy can operate at any level of output and not necessarily at full capacity.
input prices
the factor which is used in its production such as raw material, labour, machine, etc.
what happens when output and employment are low
firms can attract more resources without raising their prices. There is time for input prices to change but, due to the low level of aggregate demand, they do not. For example, when unemployment is high, the offer of a job may be sufficient to attract new workers.
what happens when output starts to reach its maximum state
firms begin to experience shortages of inputs and bid up wages, raw material prices and the price of capital equipment. according to new classical economists the LRAS curve is a straight line because they think that in the long run the economy will operate at full capacity
what does a Keynesian long run aggregate supply curve look like when it reaches maximum output
the curve stops curving and it becomes a straight vertical line at maximum output
new classical economists
economists who think that the LRAS curve is vertical and that the economy will move towards full employment without government intervention
how do firms make more intensive use of their intensive of their existing reosurces
workers may be asked to work overtime and capital equipment may be operated for long periods before undertaking routine maintenance
what do new classical economists think when there is an increase in output in the short run
they think that a rise in aggregate demand may increase output in the short run by encouraging firms to make more intensive use of their existing resources.
what happens in the long run when the resources are used intensively
this more intensive use of resources will raise costs of production. The economy will move onto a new SRAS curve and back to the LRAS curve. Output will return to the initial level but at a higher price level,
what increases the productive potential of an economy
caused by a change in the quantity and/or quality of resources
how does net immigration increase quantity of resources
Net immigration will increase the size of the labour force if the immigrants are of working age.
how does an increase in the retirement age increase quantity of resources
This will increase the size of the labour force. A number of countries have raised the age at which people can receive a state pension and some of these countries plan to raise it even further in the future as life expectancy increases.
how does an increase in women entering the labour force increase quantity of resources
The proportion of women who work varies from country to country. more women means larger size of labour force
how does net investment increase quantity of resources
gross investment (total investment) exceeds depreciation (capital goods that have to be replaced because they have become worn out or out of date) there will be additions to the capital stock.
how does discovery of new resources increase quantity of resources
The discovery of, for instance, new oil fields or gold mines can increase a country’s productive potential.
how does land reclamation increase quantity of resources
For instance, in recent years, Dubai has added considerably to its land area by reclaiming land on which it has built apartments, hotels, marinas, theme parks and beaches.
land reclamation
the creation of new land from the sea
how does improved education and training increase the quality of resources
this will increase the skills of workers and so raise labour productivity
how do advances in technology increase the quality of resources
these both reduce cost of production and increase productive capacity
macroeconomic equilibrium
the equilibrium output and price level achieved where AD and AS
macro disequilibrium
if the price level was below the equilibrium level then the excess demand would push the price level back up to equilibrium level.
if the price level was above the equilibrium level then some goods and services would not be sold and firms would have to cut their prices
what happens to the economy when there are changes aggregate demand and aggregate supply
the economy will move to a new macroeconomic position. where that position will be depends on the direction of the change, size of the change and the initial level of economic activity. For example, an economy may initially be operating below but close to its productive potential. In this case, an increase in aggregate demand may increase output, employment and the price level.
