Comsumption Flashcards
What is the wealth effect?
Refers to when changes in price level affect the real value of people’s wealth
What happens when the price level increases
When the PL rises, the real value of wealth falls, people then cut back on their spendings
Leads to movement to the left of the AD curve
What happens when the price level decreases?
When PL decreases, the real value of wealth increases, people increase their spending
Movement to the right along the AD curve
What is the international trade effect?
The international trade effect speaks about the change in value of exports and imports
What happens when the price level increases?
Rising price level produces a fall in exports and a rise in imports, so net trade falls
Imports are cheaper whereas exports are more expensive. This represents a fall in output demanded which causes a movement to the left along the AD curve
What happens when the price level decreases?
Falling price level produces a rise in exports and a fall in imports so the net trade rises
Exports are cheaper whereas imports are more expensive. This shows a rise in output demanded which causes a movement to the right along the AD curve
What is the interest rate effect?
Refers to when changes in price level affect the rate of interest
What happens when the price level increases?
If there is an increase in the price level, consumers and firms need more money Yk carry out their purchases and transactions.
This leads to an increase in the demand for money which leads to an increase in the rates of interest
This increases the cost of borrowing leading to a decreased in consumer purchases which are financed by borrowing
A movement to the left along the AD curve
What happens when the price level decreases?
If there is a decrease in the price level, consumers and firms need less money to carry out their purchases and transactions
This leads to a decrease in the demand for money which leads to a decrease in the rates of interest
This decreases the cost of borrowing leading to an increase in consumer ourchases which are financed by borrowing
A movement to the right along the AD curve
What factors affect consumer spending?
Real disposable income
Direct taxation
Consumer confidence and expectations
The rate of interest
The supply of credit
Expectations of inflation
What effect does real disposable income have on consumer spending?
An increase in real disposable income will allow consumers to spend more. This is the most important factor affecting consumer spending
What effect does direct taxation have on consumer spending?
If there is a cut in direct taxation, other factors remaining the same, consumers will experience an increase in their disposable income and increase spending
In contrasting, a rise in indirect taxes such as import duties or VAG will cause prices to rise and real incomes to decline and decreased spending
What effect does consumer confidence have on consumer spending?
Fears of rising unemployment and expectations of higher taxes will hit consumer sentiment and spending, it will decrease spending
As a consumer gets more confident, they will increase spending
What effect does rate of interest have on consumer spending?
Higher interest rates means that it costs more to borrow money so people will not borrow and this will lead to less consumer spending. Lower interest rates will lead to more consume spending
What effect does supply of credit have on consumer spending?
A lower supply of credit means that consumers can’t borrow to spend, thus consumer spending falls
A higher supply of credit means that consumers can borrow more money to finance spending, therefore consumer spending increases
