Aggregate Demand (L3) Flashcards
Aggregate demand
Tot amount of spending on goods and services produced in an economy during a period of time
AD formulae
Consumption + investment + government spending + (exports-imports)
AD= C+ I + G + X- M
What does the AD curve show
Relationship between aggregate demand and overall price level, total amount of goods and services demanded in an economy at any given overall level of prices
Reasons for the downwarding sloping AD curve
Wealth
International trade
Interest rate
The wealth effect (AD curve)
Changes in price level affect the real value of peoples wealth. If price levels go up then the real value of wealth falls. People cut back spending on goods + services so less output is demands, causing an upward movement in the AD curve and vice versa
The international trade effect (AD curve)
If domestic price level increases while staying the same in other countries, exports become more expensive to foreign buyers who demand a smaller quantity. Goods in other countries become cheaper so domestic buyers increase purchases. More imports than exports = upward movement and vice versa
The interest rate effect (AD curve)
Increase in price levels mean producers + firms need more money to make purchases,increase in demand for money so an increase in interest rates. Cost of borrowing increases so consumer purchases + investment funded by borrowing decreases. Increase in price level = fall in quantity demanded = upward movement along AD curve
What does a rightward shift show
Aggregate demand increases, for any price level a larger amount of real GDP is demanded
What do you label the axis with
Price level (y axis) Real GDP (x axis)
Determinants of consumption
Consumer confidence Interest rates Wealth Personal income taxes Household indebtedness
Changes in consumer confidence (consumption)
Consumer confidence is how optimistic consumers are about their future income + future of their economy. AD curve shifts right when it’s high.
Changes in interest rates (consumption)
Some consumer spending is financed by borrowing so is influence by interest rate changes. Increase in interest rates makes borrowing more expensive, lower consumer spending, leftward shift.
Changes in wealth (consumption)
Increase (e.g stock market values, value of homes) shift right as people feel wealthier.
Changes in personal income taxes (consumption)
Increase in personal income taxes then disposable income decreases so spending falls so AD curve shifts to the left.
Changes in the level of household indebtedness (consumption)
How much people owe from taking out loans in the past. High level of debt = shifts AD curve to the left
