How The Macroeconomy Works Flashcards
Consumption
Total planned spending by households on consumer goods and services produced within the economy
Saving
Income which is not spent
Withdrawal
A leakage of spending power out of the circular flow of income into savings, taxation or imports
Investment
Total planned spending by firms on capital goods produced within the economy
Injection
Spending entering the circular flow of income as a result of investment, government spending and exports
What are the components aggregate demand
consumption, investment, government spending, net exports
How is Aggregate Demand calculated?
Consumer Spending + Investment + Government Spending+ (Exports-Imports)
What factors affect consumption?
Interest rates Income level Expected future income Wealth Consumer confidence The availability of credit Distribution of income Expectations of future inflation
How do interest rates affect consumption?
Interest rates reward savers for sacrificing current consumption and therefore the higher the interest rate the higher reward, the more reduced consumption is. The opposite happens if interest rates fall.
How does income level affect consumption?
As income levels rise, absolute consumption rises but as it makes up a smaller part of income consumption decreases as people are saving more. The opposite happens if income levels fall.
How does expected future income affect consumption?
People plan their savings on the basis of a long-term view of their expected lifetime or permanent income over their expected lifetime.
How does wealth affect consumption?
If a wealth asset increases in price it causes increased consumption as they feel as if they have more money due to positive equity (wealth effect), the create a ‘feel-good’ factor that increases consumption as well as the fact that banks allow increased borrowing as they have more leverage. The opposite happens if wealth prices drop.
Aggregate Demand
The total planned spending on real output produced within the economy
Aggregate Supply
The level of real national output that producers are prepared to supply at different average price levels
Economic Shock
An unexpected event hitting the economy. Economic shocks can be demand-side or supply-side shocks (and sometimes both) and unfavourable or favourable.
Rate of interest
The reward for lending savings to somebody else (e.g. a bank) and the cost of borrowing
Multiplier effect
The relationship between a change in a component of aggregate demand and the resulting usually larger change in the national income
What is it important to note about the multiplier effect?
It can work in reverse as a fall in a component in aggregate demand can cause a larger than proportional decrease in aggregate demand. Tax and import multipliers are always negative.
What is the main link between employment and aggregate demand?
As more is demanded in the economy more output has to be produced and therefore more people need to be employed to increase the output.
Short Run Aggregate Supply
Aggregate supply when the level of capital is fixed, though the utilisation of existing factors of production can be altered so as to change the level of real output.
What two assumptions are made during the use of the SRAS curve?
All firms aim to maximise their profits and the cost of producing extra units of output increases as firms produce more output.
What cause the SRAS to shift?
Change in production costs (could be due to taxes or subsidies or change in labour and commodity prices)
Technical progress
Long Run Aggregate Supply
Aggregate supply when the economy is producing at its production potential. If more factors of production become available or productivity rises, the LRAS curve shifts to the right
What is it important to note about the LRAS curve?
Aggregate supply is not influenced by a change in price level and therefore it is completely vertical.
