Aggregate Demand And Supply Flashcards
What does aggregate mean
Added together, the individual elements that were introduced in microeconomics are totalled in macroeconomics.
Aggregate demand (AD) and aggregate supply (AS) analysis brings what together?
Brings together the amount that consumers wish to consume and firms wish to produce at any price level.
The equilibrium point where AD meets AS determines…
The average price level and the equilibrium real output level. The price level can be measured by a price index such as the CPI and the output by the real GDP.
Define aggregate demand
Aggregate demand (AD) is the total planned expenditure on goods and services produced in an economy over a period of time.
Define aggregate supply
Aggregate supply (AS) is the total planned output of goods and services in an economy over a period of time.
What does aggregate demand comprise of
Aggregate demand comprises of consumption (C), investment(I), government expenditure (G), and exports (X) minus imports (M)
What’s the formula for AD
AD = C + I + G + (X - M)
When the price level falls, the level of AD expands along the AD curve; when price level rises, the AD contracts.
What’s a common misunderstanding to do with why the AD curve is downwards sloping
The curve Is downwards sloping but NOT because people buy more when they are cheaper.
Tell me a reason why the AD curve is downwards sloping to do with lower prices and competitiveness
Lower prices in an economy mean increases international competitiveness, so there are more exports and fewer imports. In other words, net exports are higher at lower prices.
Tell me a way to explain why the AD curve is downwards sloping to do with the real balance effect
Total expenditure by the economy remains much the same along the AD curve. For example, when there is a fall in the price level, people still spend approximately the same amount but they buy a larger amount of goods and services. This is called the real balance effect.
Tell me a way to explain the downward sloping AD curve to do with higher price levels
At higher price levels, interest rates are likely to be raised by the monetary authorities. This means that investment - a component of AD - falls and savings might increase.
What is the main component of AD
Consumption, approximately 60%
What is consumption
Consumption is equal to spending by households on goods and services, it comprises approximately 60% of AD.
It measures the amount that consumers wish to spend at various price levels. If you ignore tax and spending on imports, a persons income is either spent (C) or saved (S). The higher the income after tax (disposable income), the more people are likely to spend, but they might spend at a slower rate as they earn more I.e - people tend to save a higher proportion of their income as their income rises.
What are the key factors that affect consumption (spend rather than save)
Amount of disposable income
Consumer confidence
Interest rates
The housing market
What’s a determinant of consumption to do with disposable income
The higher the income after tax (disposable income), the more people are likely to spend, but they might spend at a slower rate as they earn more - I.e people tend to save a higher proportion of their income as income rises.
Tell me about a determinant of consumption to do with confidence
The more people feel they need to save, the less they spend, or vice versa. One of the key determinants of consumption is confidence of the consumer. Confidence is influenced by factors such as job security and future income prospects. If consumers are feeling confident, they are more likely to make large purchases that they can pay for in the future.
Tell me about the determinant of consumption: interest rates
Higher interest rates not only leave consumers with less spending money after mortgage payments on house purchases, but they also increase the cost of borrowing.
Tell me how the housing market is a determinant of consumption
When house prices accelerate upwards, home owners can extract more equity from their houses. (Wealth effect will later be discussed dw 🐷)
There is generally a positive correlation between the growth in consumer spending and
The growth in real output
Tell me about investment as a component of AD
Investment is an increase in the capital stock. It means creating assets that will generate income in the future rather than in the immediate term. Investment firms around 10-15% of AD, but the figure depends on whether you are considering gross or net investment.
What is gross investment
Gross investment is the total amount of investment before any account is taken of depreciation of assets. Capital loses value as it wears out or becomes less efficient. Many machines become totally redundant as new methods of production are invented and the investment in these machines does not have any long term benefit on the economy.
What is net investment
It takes account of the fall in value of capital assets. It is more significant for changes in the productivity of an economy and its productive potential.
List the factors that influence the amount of investment
Interest rates
Profits of businesses
Taxation
Government policy
Exchange rate
Access to credit
New technology
Business confidence
How are interest rates a factor that influences investment
An inverse relationship between interest rates and the level of investment would be expected. This is because increases in the capital stock have to be financed and there is an opportunity cost to that finance. Firms often borrow from banks to finance investment, so if interest rates rise, the cost of borrowing rises and firms are less likely to borrow and therefore less likely to invest. The prospects for future interest rates may be more significant than the current rate of interest and many firms watch closely the decisions on interest rates made by the Monetary Policy Committee. However, some argue that the interest elasticity of demand for investment is very low because other factors are much more significant.