Macro L3 Flashcards
What are the reasons for a downward sloping AD curve?
- Wealth effect
- International trade effect
- Interest rate effect
Explain the wealth effect as a reason for a sloping AD curve
- As price levels increase, the value of wealth decreases as people feel worse-off and cut back on spending
- Less output is demanded (upward movement on AD curve)
What is wealth?
Value of assets people own
Explain the international trade effect as a reason for a sloping AD curve
- if domestic price level increases whilst other countries’ remain the same, exports fall as they are more expensive and imports rise as goods in other countries become relatively cheaper
- Net exports fall resulting in fall of output demanded (upward movement on AD curve)
Explain the interest rate effect as a reason for a sloping AD curve
- If price level increases, there is a greater demand for money
- Interests rates increase because of this leading to decrease in consumer purchases financed by borrowing and investment spending by firms
- Fall in output demanded (upward movement on AD curve)
What does each shift in an AD curve show?
- Rightward shift –> Increase in AD
- Leftward shift –> Decrease in AD
What tends to happen as real income rises?
Households tend to spend more
Marginal propensity to consume:
Proportion of increase in disposable income that households would devote to consumption
Marginal propensity to save:
Proportion of increase in disposable income that households would devote to saving
What are the determinants of consumption?
- Change in consumer confidence
- Change in interest rates
- Change in wealth
- Change in level of household indebtedness
Consumer confidence:
How optimistic consumers are about their future income and the future of the economy
What is the impact of a change in consumer confidence on consumption?
Greater the consumer confidence, the more likely consumers are to spend, increasing consumption resulting in a right shift in AD curve
What is the impact of a change in interests rates on consumption?
As interest rates increase, borrowing becomes more expensive, decreasing consumption which causes a left shift in AD curve
What causes a change in interest rates?
Monetary policies
What is the impact of a change in wealth on consumption?
As consumer wealth increases, greater consumer confidence, which increases consumption and results in a right shift in AD curve
What causes a change in wealth?
Change in taxes as a result of fiscal policies
What is the impact of a change in the level of household indebtedness on consumption?
A high level of debt results in lower consumer confidence and so lower consumption which causes a left shift on AD curve
Investment:
Addition to capital stock that produces other goods and services
Gross investment
Investment before depreciation
Net investment
Gross investment after depreciation
Depreciation
Capital consumption
Physical capital
Investment in factories
Human capital
Investment in education and training of workers
What are the determinants of investment?
- Change in business confidence
- Change in interest rates
- Change in improvements in tech
- Change in business taxes
- Level of corporate indebtedness
- Legal/institutional changes
What is the impact of a change in business confidence on investment?
More business confidence means more investment spending and greater AD
What is the impact of a change in interest rates on investment?
- Higher the cost of borrowing, less profitable investment projects become, number of profitable investment projects decrease, less investment spending, less AD
- Higher the cost of borrowing, more attractive to save (retained profit) rather than spending on capital, less investment spending, less AD
What is the impact of a change in technology on investment?
It stimulates investment, so greater AD
What is the impact of a change in business taxes on investment?
Firms’ after-profits fall, less investment spending, less AD
What is the impact of a change in levels of corporate indebtedness on investment?
Less business confidence, less investment spending, less AD
What is the impact of legal/institutional changes on investment?
Laws and institutions may not favour small businesses eg. decrease in credit (ability to borrow), more investment spending, greater AD
Define aggregate demand
Total amount of spending on goods and services in an economy during a period of time
Define aggregate supply curves
The sum of all the industry supply curves in the economy
