Aggregte Demand Flashcards
Aggregate Demand
Total planned expenditure within an economy over a SPOT
Components of AD
Consumption
Investment
Government spending
Exports
Imports
AD equation
C+I+G+(X-M)
Trade Surplus
When exports > imports this increases AD
Trade Deficit
When imports > exports this decrease AD
AD and Price have an Inverse relationship because (3)
Real balance effect
Balance of trade
Interest rate effect
CPI
Stands for consumer price index and measures inflation
Real balance effect
As the price level rises, real income falls and consumers are able to buy less
Balance of Trade
A persistent price rise of a countries goods will make foreign good cheaper, increasing imports and decreasing exports
Interest rate effect
• Price rises cause inflation
• This increases demand for money •Interest rates will rise and have a negative effect on the economic growth
•People will save more and spend less therefore AD falls
What causes a right shift in AD (5)
Depreciation of exchange rate
Tax Cuts
Increase in house prices
Expansion of supply of credit
Lower interest rates
What causes a left shift in AD (4)
Fall in exports
Cut in government spending
Higher interest rates
Decline in household wealth
External shocks
Many unexpected events cause changes in demand, output and employment
External shock examples (5)
• Big exchange rate change
• Recession of a trading partner
• Slump in housing market
• Credit crunch
• Change in government taxation and spending
Consumption
All household spending on G/S
Marginal Propensity to consume
The change in consumer spending following a change in income
Marginal Propensity to consume example
Disposable income: £2000
Spending: £1500
Saving: £500
MPC: 1500/2000=0.75
MPS: 500/2000=0.25
MPC + MPS always =
1
Factors affecting consumer spending (6) 🇳🇬
Tax
Welfare
Interest rates
Confidence
Economy
Job security
Factors affecting consumer confidence (4)
Economic growth
Household debts
Unemployment
House prices
Household saving
Disposable income that is not spent, spending is postponed to a later date
Macro importance of saving (3)
Business survival
Funding investment
Buffer for consumers
Investment
Spending on Capital goods
Examples of investment (5)
Factories
Buildings
Machinery
Technology
Vehicles
Key factors determining business investment (4)
Actual and expected demand
Expected profits and business taxes
Interest rates + availability of finance
Business confidence
Macro advantages of investment and evaluation (3)
• Injections boost AD but some investment could be imported, this is a leakage
• New capital can boost productivity and increase supply but there can be a time lag
• Creates extra demand in investment and boosts GDP, capital could lead to short term unemployment
The accelerator theory
A percentage increase in real GDP will lead to an even higher percentage increase in investment
Government spending is effected by (4)
Developments in the economy
The political priorities of the Gov
National debt
Geo-political factors
Consequence of National debt
Crowding out
Exports
G/S sold to other countries, its an injection into a nations CFOI
Factors affecting demand for exports (4)
• Relative price of exports
• The exchange rate (SPICED)
• Non-price demand factors (brands and quality)
• Strength of the economy in key export markets
Imports
G/S bought from other countries they are a withdrawal from a nations CFOI
Net Trade Balance
Measures the value of exported G/S minus the value of imported products
Hot Money Flows
Higher interest rates in the UK provide incentives for foreign investors to move money into UK banks
Increases in interest rates (foreign investment)
UK becomes more attractive location for investors as they can seek higher returns. Foreign investors purchase pounds to invest in UK banks, demand for the pound rises raising the price of the pound
Decrease in interest rates (foreign investment)
UK becomes less attractive for foreign investors as there are lower rates of return. Foreign investors sell the pound to purchase other currencies, supply of the pound increases and this decrease the price of the pound.
Strong Pound
Strong
Pound
Imports
Cheaper
Exports
Dearer
Weak Pound
Weak
Pound
Imports
Dearer
Exports
Cheaper
Multiplier effect
An increase in a component of AD leads to a greater than proportionate increase in GDP.
Someone’s spending is someone’s income, they spend money and a ripple effect occurs.
Determinant of the size of the Multiplier effect
Marginal Propensity to Withdraw (MPW)
Equation for multiplier effect
Multiplier
————-
MPW
