Dec Test Flashcards
What is Aggregate Demand?
The total of all demands or expenditures in the economy at any given price
What does Aggregate mean?
The sum or total
What does the Aggregate Demand Curve show?
The relationship between the price level and equilibrium national income.
As the price level rises, the equilibrium level of national income falls.
What is a Domestic Economy?
The economy of a single country.
Why is the AD Curve downward sloping (Consumption/ Interest Rates)?
When prices increase (inflation), consumers and firms need more money to purchase the same amount of goods and services a before.
One way of acquiring more money is through borrowing it, and so the demand for borrowed funds will rise.
However, if there is a fixed supply of money available for borrowing from banks and building societies, the price of borrowed funds will rise.
This price is the rate of interest.
A rise in IR leads to a fall in C, particularly of durable goods such as cars, which are commonly purchased on credit.
Why is the AD Curve downward sloping (Consumption/ Wealth Effect)?
A rise in price level leads to the real value of an individual consumer’s wealth being lower.
A fall in real wealth will result in a fall in consumer spending
Why is the AD Curve downward sloping (Investment)?
A rise in prices, ceteris paribus, leads to a rise in interest rates in the economy.
The higher the rate of interest, the less profitable new investment projects become and therefore, the fewer projects will be undertaken by firms.
Thus, the higher the interest rate, the lower the level of investment.
Why is the AD Curve downward sloping (Government Spending)?
Government spending is exogenously determined, fixed by variables outside the model.
In this case, it is assumed to be determined by the political decisions of government of the day.
Government spending here does not include transfer payments. These are payments by the government for which there is no corresponding output in the economy, like welfare benefits or student grants.
Why is the AD Curve downward sloping (Imports and Exports)?
A higher price level in the UK means that foreign firms will be able to compete in the UK economy.
E.g. if British shoe manufacturers increase their prices by 20%, whilst foreign shoe manufacturers keep their prices the same, then British shoe manufactures will become less competitive and more foreign shoes will be imported.
Equally, British shoe manufacturers will find it more difficult to export charging higher prices. So, a higher UK price level, with price levels in other economies remaining the same, will lead to a fall in UK exports.
Hence, AD falls as prices rise, first because of increases in interest rates reduce consumption and investment and, second, because a loss of international competitiveness at the new higher prices will reduce exports, and increase imports.
What are the components of AD?
C+I+G+(X-M)
What are the determinants of Consumption?
A fall in unemployment would increase consumer confidence, as consumers become less afraid of losing their jobs and more willing to borrow money to spend on consumer durables.
The government or central bank may reduce interest rates, again encouraging brewing for durable goods.
A substantial rise in stock market prices will increase consumer wealth, which in turn may lead to an increase in spending.
A reduction in the relative numbers of high saving 45-60-year-olds in the population will increase the average propensity to consume (the proportion of total income that is spent) of the whole economy.
New technology, which creates new consumer products, can lead to an increase in consumer spending as households want to purchase these new products.
A fall in income tax would increase consumers’ disposable income, leading to a rise in consumption.
What is Consumption?
The total expenditure by households on goods and services over a period of time.
What is Investment?
The addition to the capital stock of the economy
What is Gross Investment?
The addition of capital stock, both to replace the existing capital stock which has been used up (depreciation) and the creation of additional capital.
What is Net Investment?
Gross investment minus depreciation
What is Retained Profit?
Profit kept back by a firm for its own use which is not distributed to shareholders or used to pay taxation, and can be used to fund investment.
What is the Depreciation of Capital Stock?
The value of capital stock which has been used up or worn out.
What are the determinants of Investment?
An increase in business confidence would increase investment. This could come have come about, for instance, because the economy was entering a boom.
A fall in interest rates ordered by the government would lead to a rise in investment.
An increase in company profitability would give firms more retained profit to use for investment.
A fall in corporation tax would lead to the rate of return on investment projects rising, leading to a rise in investment.
What are the determinants of Government Spending?
Government spending can change automatically because of the spending commitments of previous governments (discretional fiscal policy)
A rise in government spending with no change in taxation will lead to a fall in its budget surplus or a rise in its deficit; this will increase AD.
A fall in government spending with no change in taxation will lead to a shift to the left in the AD curve.
It also depends on the governments spending priorities.
Automatic stabilisers
What are the determinants of Net Exports?
A rise in the exchange rate is likely to lead to lower exports, but higher imports as less of a particular currency is requires to purchase a certain good or service. As a result, net exports would therefore fall, reducing AD.
An improvement in innovation and quality of UK manufactured goods is likely to lead to a rise in exports. This will increase AD and shift the curve outwards.
Real income in the domestic economy: if the economy is doing well and real incomes of households are rising, then they may spend more; part of this spending will be on imported goods. Thus, rising real incomes increase imports.
State of the world economy: if the UK’s main trading partners are doing well economically, then UK exports are likely to rise. By far the largest export market for the rest of the EU. Recession in the EU could lead to a fall in UK exports whereas fast EU economic growth will boost UK exports.
Degree of protectionism: Quotas (physical limits on the amount that can be imported) on goods and tariffs (a tax on imports) can make it difficult for UK firms to export. An advantage of the UK’s membership of the EU s that barriers to trade are very low for exports to countries such as France and Germany.
What is the distinction between a movement along and shift of the AD curve?
If the change has come about because the price level has changed, then there is a movement along the AD curve. E.g. a rise in the price level causes a rise in interest rates. This leads to a fall in consumption and is shown by a movement put he curve.
If however, interest rates or consumer spending have changed for a different reason than because prices have changed, there here will be a shift in the AD curve.
A government increase in interest rates at a given price level would lead to a shift in the curve.
What is Supply-Side Economics?
The study of how changes in aggregate supply will affect variables such as national income; in particular, how government microeconomic policy might change aggregate supply through individual markets.
What does ‘Supply-Side’ mean?
An economy’s ability to produce goods and services.
What does the ‘Short-Run’ mean?
The period of time when money wage rates and the prices of all other factor inputs in the economy are fixed.
