MACR Flashcards
Aggregate demand definition
Total demand of domestically produced goods and services that buyers collectively desire to purchase at each GPL in a given time period
What makes up AD
C+I+G+(X-M) which is the planned consumption expenditure + Investment expenditure + government expenditure + net total export expenditure on goods and services
What is the wealth effect?
Assuming unchanged nominal wealth, a fall in GPL will increase the real value of households wealth. As their PP increases they are more willing to consume goods and services hence consumption rises and so does real gdp
What is the interest rate effect?
When GPL falls, households and firms require less money to conduct their activities which means they have more money to save, increasing supply of loanable funds in the market. This will place a downward pressure on interest rates making it cheaper for households to borrow and purchase consumer goods and services. Thus, C and I rises causing rise in real GDP
What is the international sub effect?
When domestic GPL falls, assuming no change in the foreign exchange rate and foreign prices, price of local goods relative to domestic goods falls making domestic goods more price competitive. Thus, import expenditure decreases as households switch to buying cheaper domestic goods while export revenue increases from foreigners buying local goods. Hence net exports increases so GDP increases
what is autonomous consumption
changes in consumption arising from non-income factors
what is induced consumption
changes in consumption arising from changes in income
Factors of Shifts in AD
- expectation of future income levels
- expectation of changes in households real wealth
- expectations about future change in GPL
- Availability of credit
- interest rates
- personal income tax
elab about future income level
optimism in future state of economy means high consumer confidence as expanding economy brings abt job vacancies and higher income. hence when households expect economy to do well they also expect a higher income stimulating consumption as they are more willing to buy big-ticket
alab abt changes in households real wealth
if they expect increase in real value due to stock market or property boom etc, this prompts them to save less and be willing to consume more as they feel wealthier so ad rises
future change of gpl
expect inflation rate to rise, bring forward their consumption to avoid paying higher prices in the future, increase in willingness of household to consume goods and services now
interest rates
fall in interest rates means cos of borrowing money is lower so households more willing to borrow and spend since the int payments are lower and more affordable. since the return of savings also decreases, this increases their willingness to consume more in the present since opp cost is lower
factors affecting planned investment expenditure
interest rates and expected rate of return for the investments and availability of credit
elab about interest rates
Interest is the cost of investments by firms. The lower the interest rates, less expensive it is for firms to finance their investments because they finance the purchase of capital goods through borrowing which requires them to pay interests to their creditors or by using undistributed profits causing them to forgo the interest they would have received if they put them in the bank. However, with lower interest rates, investments which were previously unprofitable are now profitable due to higher expected rate of return which is more than interest rates hence they will be taken.
expected rate of return of the investments
expectations abt future - expanding economy and improved profit margins make them want to increase their capacity by buying more capital
tech advancements that give rise to new business opp
explain the multiplier effect
Assuming economy is operating at spare capacity, increase in AD due to autonomous spending would lead to AD exceeding current level of output. As firms draw on their inventories to meet this unexpected increase in AD, there will be an unplanned fall in inventories for firms. Thus, to increase their output to meet planned levels of inventories, they will hire more FOPs such as labour to increase production so national income increase. As households receive more factor income for factor services, they spend a portion of the additional income on domestic goods and services, causing a rise in induced consumption and thus AD. With this increase in spending it creates another round of unplanned fall in inventories and the process repeats itself where households spend part of the income on consumption of domestic goods and services and the rest on savings taxes and imports. This process of increase in induced consumption will continue until total withdrawals = total injections again.
Assuming economy is operating at spare capacity, an increase in autonomous spending will result in the AD increasing. and exceeding the current level of output. As a result, firms will have to draw from their inventories in order to meet the increased AD. This causes an unplanned fall in inventories. They have to increase their output to then meet the planned levels of inventories so they hire more FOPs including labour. In response, the national income will increase. As households receive more factor income for their factor services, this increases their induced consumption as they spend a portion of the increased income on consumption of domestic goods and services. This result in another increase in AD which creates another round of fall in unplanned inventories and the process repeats itself where households spend part of their additional income on consumption of domestic goods and services with the rest on savings, taxes and imports. This process of increase in induced consumption continues until total withdrawals=total consumption
multiplier (k) = 1/(MPW) +1/(1-MPC)
where MPC is the marginal propensity to consume/withdraw
talk about the factors of MPC and MPW
MPS is affected by
- countrys attitude towards thrift - some thriftier country save more
- social security system - country’s with lack of SS system
- government policy - forced savings like CPF
- distribution of income - wider income gap increases MPS
MPT affected by
1.countrys tax systems
MPM affected by
1.countrys factor endowment - lack of natural resources so they have to import most of their goods
What affects the extent of multiplier effect
Leakages - With a higher MPW, this means more of the increased income is leaked out of the circular flow in each round and less is spent on IC of domestically produced goods and services thus overall increase in NI smaller
lack of spare capacity - when full- employment is reached, any further increase in expenditure will only increase nominal NI
Structural rigidlness
time lag
what causes shift in horizontal AS?
- Price of factor inputs
- exchange rate
- government policies
