CH23 The characteristics of aggregate demand Flashcards
What does the aggregate demand curve show?
it shows the relationship between the price level and equilibrium output in the economy / real expenditure in the economy
What does a movement along the aggregate demand curve show?
Shows how real output will change if there is a change in the price level
What does aggregate mean in economics?
it means ‘total or ‘added up’ amount
What is aggregate demand?
it is the total of all demands or expenditures in the economy at any given price
What is aggregate demand the same as?
the same as national expenditure
National expenditure is one of the three ways of calculating what?
of calculating national income, usually through GDP
What are the 4 components that make up national expenditure?
1) Consumption (C)
2) Investment (I)
3) Government spending (G)
4) Exports minus Imports (X-M)
What is the consumption component?
it is the spending by households on goods and services
What is the investment component?
it is the spending by firms on investment goods
What is the government spending component?
it includes current spending, for instance on wages and salaries. It also includes spending by government on investment goods like new roads or new schools
What is the exports minus imports component?
-foreigners spend money on goods produced in the domestic economy. Hence it is part of national expenditure
-However, households, firms and governments also spend money on goods produced abroad. These imported goods do not form part of the national output and do not contribute to national income.
-So because C, I, G, and X all include spending on imported goods, imports (M) must be taken away from C + I + G + X to arrive at a figure for national expenditure
What is the formula to calculate aggregate demand / national expenditure?
AD = C + I + G + X - M
Why is the aggregate demand curve downwards sloping?
because an rise in the price level will result in a fall in the equilibrium level of national income and therefore of national output. If prices rise, demand will fall, so expenditure falls.
-consider what happens to a household budget if prices rise. If a household is on a fixed income, then a rise in average prices will mean that they can buy fewer goods and services than before. The higher the price level in the economy, the less they can afford to buy. So it is with the national economy. The higher the prices, the fewer goods and services will be demanded in the whole economy
What does a more sophisticated explanation of why the aggregate demand curve slope downwards consider?
it considered what happens to the different components of expenditure when prices rise
What happens to consumption when prices rise?
consumption expenditure is influenced by interest rates. When prices increase, consumers (and firms) need more money to buy the same number of goods and services as before. One way of getting more money is by borrowing, so the demand for borrowed funds will rise. However, if the rate of interest is high consumers are less likely to borrow money. So a rise in interest rates leads to a fall in consumption, particularly of durable goods such as cards
-another way a rise in the price level affects consumption is through the wealth affect. A rise in the price level leads to the real value of an individual consumer’s wealth being lower. So a fall in real wealth will result in a fall in consumer spending
