macro 2.2, 2.3, 2.4 and 2.5 - AD, AS, national income and economic growth ✅ Flashcards
aggregate demand (AD)?
AD- total demand for a countries goods/services at a given price level in a given time period
equation?
AD= C+I+G+NX
- consumption (C) —> consumer spending on goods and services —> makes up around 65% of AD
- investment (I) —> when firms spend money on capital goods to increase their productive capacity e.g. new equipment —> makes up around 15-20% of AD
- government spending (G) —> makes up around 18-20% of AD
- net exports (NX) (X-M) —> large trade deficit in the UK (imports > exports) —> makes up around 5% of AD
AD curve?
what does the AD curve show?
- shows the inverse relationship between price level and real GDP
what causes movement along AD curve (extension/contraction in AD)
- a movement along the AD curve is caused changes in the price level
- an increase in price causes a contraction in demand
- a decrease in price causes an extension in demand
how do changes in the price level affect AD?
- wealth effect —> as price level decreases from P1 to P2 —> purchasing power increases —> people are richer —> consumption increases —> extension of AD
- trade effect —> as price level decreases from P1 to P2 —> exports become more competitive —> demand for exports increases —> revenue from exports increases// imports become less competitive as domestic goods and services are more competitive —> import expenditure decreases —> X-M increases —> extension of AD
- interest effect —> if inflation is low (P2) then interest rates can be kept low —> ROR on savings decreases —> greater incentive to spend —> MPC increases —> consumption increases —> extension of demand
what causes the AD curve to shift?
- a shift of the AD curve is caused by a change in the components of AD = C + I + G + (X-M)
- shift to the right —> increase in AD
- shift to the left —> fall in AD
consumption (WICT)
wealth effect:
- when house prices increase, people will feel wealthier —> higher MPC —> consumption increases —> AD shifts right
interest rates:
- interest rates are cut —> cost of borrowing falls and ROR on savings fall —> increases incentive to borrow money and decreases incentive to save —> consumption increases —> AD shifts right
confidence levels:
- high confidence in job prospects and state of the economy e.g. pay rises and low likelihood of unemployment —> higher MPC —> consumption increases —> AD shifts right
taxes:
- income tax decreases —> disposable income increases —> MPC increases —> consumption increases —> AD shifts right
disposable income - money consumers have left to spend, after taxes have been taken away and any state benefits have been added
consumption is the largest component of AD —> makes up around 65% of AD
multiplier effect, accelerator effect, marginal propensities
- multiplier effect - an initial increase in AD will lead to an increase in economic growth which will lead to a further increase in AD (opposite is called downward multiplier effect)
- evaluation - the size of the multiplier is dependent on the size of withdrawals/leakages - the higher the leakages, the smaller the multiplier
diagram for positive multiplier effect:
- normal AD and AS diagram with 3 shifts in AD
marginal propensities:
- MPC - the proportion of additional income that is spent - MPC = change in consumption/change in income
- MPS - the proportion of additional income that is saved - MPS = change in savings/change in income
- MPC + MPS = 1
- MPT - the proportion of additional income that is paid in tax - change in tax/change in income
- MPM - the proportion of additional income that is spenton imports - change in imports/change in income
calculating the multiplier:
- multiplier = 1/1 - MPC —> same as 1/MPS
- multiplier = 1/MPW —> same as 1 /MPS + MPT + MPM
- times (x) the multiplier by the initial increase in spending
factors affecting the multiplier value:
- the greater the withdrawals, the smaller the value of the multiplier and vice versa
- the greater the MPC, the greater the value of the multiplier and vice versa
- accelerator effect - as economics growth increases, investment increases
investment (CCIGA)
definitions:
- investment - when firms spend money on capital goods to increase their productive capacity e.g. machinery
- gross investment- total amount that the economy spends on new capital
- net investment- gross investment - capital depreciation
- capital depreciation- where machinery loses its value over time as it wears out or gets used up
factors affecting investment (CCIGA)
- confidence (animal spirits - john maynard keynes) —> if expectation of profit and demand is high - business confidence increases - investment increases
- interest rates - low IR - cost of borrowing falls - greater incentive to borrow money and invest - investment increases// low interest rates - ROR on savings falls - greater incentive to spend - consumption increases - business confidence increases due to increased demand - investment increases
- corporation tax (tax on business profits) - the lower the corporation tax, the higher the level of retained profit - more money to invest - investment increases
- access to credit - high access to credit - investment increases
- government regulation - can increase COP for firms - less retained profits - investment falls
net trade (DINER)
degree of protectionism:
- strong protectionism abroad - export revenue decreases —> net trade decreases (vice versa)
- strong protectionism at home - high protectionism on imports coming into the UK - import expenditure will be low - net trade increases (vice versa)
inflation:
- high relative inflation - UK exports are less competitive - demand for exports decreases - export revenue decreases - net trade decreases// import expenditure will rise as goods are cheaper abroad - net trade decreases
non price factors:
- design and branding - if UK goods are of a better design and branding - demand for exports increases - export revenue increases// demand for imports decreases as consumers will domestic goods instead of foreign goods - import expenditure decreases - net trade increases
exchange rates:
- strong exchange rate - imports cheaper - demand for imports increases - import expenditure increases//exports more expensive (less competitive) —> demand for exports decreases —> export revenue decreases —> net trade decreases (opposite for weak exchange rate)
real income/state of the economy:
- boom abroad - disposable income earned abroad increases - demand for exports increases - export revenue increases - net trade increases// recession abroad (opposite)
- boom in the UK - disposable income earned at home increases - import expenditure increases - net trade decreases// recession (opposite)
government spending
influences on government expenditure:
- business cycle - in a recession, government spending increases to increase AD// in a boom, government spending decreases
- fiscal policy - decisions about government spending - will depend on the properties of the government
- budget deficit - government spending > taxation in a fiscal year
- budget surplus - government spending < taxation in a fiscal year
- national debt - total stock of debt over time - accumulation of budget deficits
business cycle
- business cycle - shows changes in real GDP over time
diagram:
- x axis: time
- y axis: real GDP
- actual growth - rises and falls
- trend growth - upwards sloping curve
- boom - highest peak, trough - lowest peak, recession - between boom and trough, recovery - between trough and boom
- boom - actual growth is higher than trend growth - positive output gap
- trough - actual growth is lower than trend growth - negative output gap
characteristics of a boom:
- high rates of economic growth, low unemployment, high consumer and business confidence, demand pull inflation, improvement in the government budget as tax revenue increases and expenditure falls
characteristics of a recession:
- recession - 2 successive quarters of negative growth (between boom and trough)
- high unemployment, low consumer and business confidence, low demand for imports, low inflation, increase in government spending perhaps leading to a budget deficit
aggregate supply (AS)
- aggregate supply - volume of goods and services produced within the economy at a given price level
- AS curve is upwards sloping - firms are willing to supply more at higher prices
movement along AS curve (extension and contraction):
- an increase in price causes an extension in supply
- a decrease in price causes a contraction in supply
shift of entire SRAS curve:
factors influencing SRAS (changes in COP):
- changes in costs of raw materials and energy - price increases - COP increases - SRAS shifts left
- changes in exchange rates - weak exchange rate (WPIDEC) - import prices increase - increase COP for firms who use imports - SRAS shift left
- changes in tax rates - e.g. corporation tax increases - COP increases - SRAS shift left
shift of entire LRAS curve:
what causes the LRAS curve to shift:
- changes in the quantity/quality of FOP and productive efficiency
factors influencing LRAS:
- competition - productive efficiency increases as firms want to reduce costs - LRAS shifts right
- reducing welfare benefits - incentivises inactive to enter the labour force - quantity of labour increases - LRAS shifts right
- income tax cuts/corporation tax cuts - lower income tax - incentive for inactive to enter the labour force - quantity of labour increases// for those in work, greater incentive to work harder as they can keep more of their money as disposable income - quality of labour increases - LRAS shifts right// lower corporation tax - higher retained profit - investment increases - increases quality/quantity of capital
- government spending on education/training - human capital increases - quality of labour increases - LRAS shifts right
- government spending on healthcare - less absenteeism - quality of labour improves - LRAS shifts right
- government spending on housing supply/transportation - reduces labour immobility - quantity of labour increases - LRAS shifts right
classical and keynesian:
classical diagram LRAS
- LRAS curve (perfectly inelastic) - in the LR, the economy will always produce at YFE
- YFE - level of output an economy can produce using all FOP at sustainable levels (can increase output beyond YFE e.g. using FOP unsustainably - using labour overtime)
keynesian:
- supply is elastic at lower levels of output as there is a lot of spare capacity - easy to increase production
- supply is perfectly inelastic at YFE (full employment)
economic growth and output gaps
economic growth:
SR economic growth on AD/AS diagram:
- SRAS/LRAS and AD curve
- AD shifts
LR economic growth on AD/AS diagram:
- LRAS and AD curve
- LRAS shifts
SR economic growth on PPF diagram:
- draw PPF curve
- x axis: consumer goods, y axis: capital goods
- move from point A to point B - moves closer to the PPF curve
LR economic growth on PPF diagram:
- draw PPF curve
- x axis: consumer goods, y axis: capital goods
- shift PPF curve
output gaps:
- negative output gap - where actual output is less than potential output
- positive output gap - where actual output is greater than potential output
diagram (classical):
- SRAS and AD curve
- AD and SRAS = equilibrium - LRAS (YFE) curve to the left of e - positive output gap// LRAS (YFE) curve to the right of e - negative output gap
diagram (keynesian):
- LRAS curve (YFE) and AD curve
- YFE to the right of e —> negative output gap// positive output gap - draw AD on LRAS curve (inelastic part at the highest point)
circular flow of income
- circular flow of income - how money flows around the economy between households and firms
- households provide 4 FOP to firms - firms combine FOP to produce goods + services - households will receive factor incomes from firms - households will spend this on goods and services made by firms
diagram:
- households - top box
- firms - bottom box
- draw arrows from firms to households and households to firms around the outside
- outside arrows: firms —> households = factor income// households —> firms = consumer expenditure
- inside arrows: households —> firms = FOP// firms —> households = goods/services
- withdrawals/leakages - money flowing out of the circular flow of income e.g. savings (S), taxes (T) and imports (M)
- injections - money flowing into the circular flow of income e.g. investment (I), government spending (G) and exports (X)
- injections > leakages - economic growth
- injections < leakages - fall in economic growth
income and wealth:
- these are mutually reinforcing e.g. high incomes —> can purchase assets —> more wealthy
income:
- flow concept - measured over a period of time e.g. salary, profits
wealth:
- stock concept - measured at a given point in time e.g. property, cars, gold
costs and benefits of economic growth
consumers:
- higher disposable income - standard of living increases ✅
- increased employment ✅
- demand pull inflation ❌
firms:
- higher profits for firms as people have more disposable income ✅
- firms who sell inferior goods may lose out ❌
government:
- higher tax revenue due to rising income tax and corporation tax ✅
- current account deficit - income rise - demand for imports increase ❌
- environmental costs e.g. deforestation ❌
