Macro 2 - Aggregate Demand Flashcards
Define the term aggregate demand
Aggregate demand is the total planned expenditure on goods and services produced in an economy
What is the formula used to calculate aggregate demand?
AD = C + I + G + (X-M)
What are the different components that make up aggregate demand?
C - Consumer spending / Consumption
I - Investment
G - Government spending
X - Exports
M - Imports
What is consumer spending / consumption?
Consumption / Consumer spending is the total amount spent by households on goods and services. It does not include spending by firms
What effect will an increase in consumption have on aggregate demand?
An increase in consumption will increase aggregate demand
What effect will a decrease in consumption have on aggregate demand?
A decrease in consumption will decrease aggregate demand
What does the government spending component of aggregate demand refer to?
The government spending component of aggregate demand is the money spent by the government on public goods and services. Only money that directly contributes to the output of the economy is included
Are transfer payments such as benefits and pensions included in the government spending component of aggregate demand?
No
When does a budget deficit occur?
If government spending is greater than its revenue, there will be a budget deficit
When does a budget surplus occur?
If government spending is less than its revenue, there will be a budget surplus
What are exports?
Exports are goods or services that are produced in one country, then sold in another
What are imports?
Imports are goods and services that are brought into a country after being produced elsewhere
What is the relationship between exports and imports and aggregate demand?
Exports minus imports (X-M) make up the net exports component of aggregate demand
On an aggregate demand diagram what goes on the x-axis?
Real GDP
On an aggregate demand diagram what goes on the y-axis?
Price level (PL)
On an aggregate demand diagram what letter is used to represent Real GDP on the x-axis?
Y
On an aggregate demand diagram what letter is used to represent Price level on the y-axis?
P
Does the aggregate demand curve slope upwards or downwards?
Downwards
Does the aggregate demand curve slope upwards or downwards?
Downwards
Why does the aggregate demand curve slope downwards?
The lower the price level the more output is demanded. Lower prices mean consumers can buy more goods/services with their money
What effect will a change in the price level have on the aggregate demand curve?
A change in the price level will cause a movement along the AD curve
What effect will a rise in the price level have on aggregate demand?
A rise in the price level will lead to a contraction in aggregate demand
What effect will a fall in the price level have on aggregate demand?
A fall in the price level will lead to an extension in aggregate demand
Why will a rise in the price level cause output to fall?
- Domestic consumption will be reduced as things become more expensive so people can buy fewer goods and services
- The demand for exports will be reduced as domestically produced products become less competitive
- The demand for imports will increase, if prices haven’t risen abroad imports will become cheaper in comparison
If there is an increase in aggregate demand which way will the AD curve shift?
The AD curve will shift right
If there is a decrease in aggregate demand which way will the AD curve shift?
The AD curve will shift left
What causes a shift in the aggregate demand curve?
A change in the size of any of the components that make up aggregate demand
What are the factors affecting consumer spending?
- Real disposable income
- Wealth
- Consumer confidence
- Rate of interest
- Saving
Define the term real disposable income
Real disposable income refers to the flow of money earned after direct taxes and adjusted for inflation
What is disposable income?
Disposable income is income minus direct taxes
Define the term wealth
Wealth refers to the value of the stock of assets someone owns
What is the wealth effect?
The wealth effect refers to the effect on incomes or spending when asset values (wealth) changes. As wealth rises, usually consumer spending also rises
Why does consumer spending usually rise when wealth rises?
If wealth increases then individuals have a larger number of personal assets to fall back on. This may provide them with more security and confidence. It would allow them to borrow against this wealth increasing spending.
Define the term consumer confidence
Consumer confidence refers to household’s optimism or pessimism about their financial circumstances in the future based on their expectations about the economy
Explain how an increase in consumer confidence may increase consumer spending
Increased consumer confidence means people may feel more optimistic about their future prospects such as job security and possible pay increases encouraging them to spend more on goods and services
Define the term rate of interest
The rate of interest refers to the cost of borrowing or reward for saving with a financial institution such as a bank
What effect will lower interest rates have on consumer spending?
- The lower the rate of interest the higher consumer spending will be as there is less incentive to save as there is a smaller return on savings.
- It is also cheaper to borrow money so consumers may buy goods and services on credit.
- Repayments on existing debt may fall increasing discretionary income
What effect will higher interest rates have on consumer spending?
- Higher interest rates lead to less consumer spending as consumers save more as there is a larger return on savings
- It is more expensive to borrow money so spending is also likely to decrease
What effect will more saving have on consumer spending?
More saving will decrease consumer spending
Define the term investment
Investment is money spent by firms on capital goods and assets which will be used to produce more goods or services
Define the term gross investment
Gross investment is the total amount spent on investment before any account is taken of depreciation of assets
Define the term net investment
Net investment is the amount spent by firms in an economy on capital goods minus depreciation of assets.
Net investment only includes investment that increases productive capacity
What are the factors which affect investment?
- Rate of economic growth
- Amount of spare capacity
- Business confidence
- Animal spirits
- Demand for exports
- Rate of interest
- Access to credit
- Influence of government and regulations
What is meant by animal spirits?
The economist Keynes came up with the idea of animal spirits which is the idea that it was not rational thinking that made people buy or sell shares or invest but it was rather an animal or herd instinct similar to herding behaviour
What are the three types of government spending?
- Capital expenditure
- Current expenditure
- Transfer payments
What is meant by capital expenditure?
Capital expenditure relates to long-term investment projects in new assets such as hospitals or infrastructure programs
What is meant by current expenditure?
Current expenditure is day to day expenditure on goods and services to keep current services working
What is meant by transfer payments?
Transfer payments are payments made by the state from tax revenues to individuals in the form of benefits for which there is no production in return
