Pack 3 yr 12 Flashcards
Aggregate demand and supply
What is aggregate demand?
- total demand for goods and services in the economy during a time period
C + I + G + (X-M)
consumption + investment + government spending + net exports
What is disposable income?
money an individual receives after having paid any directed taxed and received any transfer payments or benefits
What is formula for marginal propensity to consume?
change in consumption/change in disposable income
What is the formula for marginal propensity to save?
change in saving/change in disposable income
What factors influence consumption?
Real disposable income: higher disposable income, able to consume more goods, results in rising consumption
Changes in income taxation: lower taxation = more disposable income to spend on goods/services
Wealth effects: greater wealth=more confidence=greater consumption
Interest rates: if they fall, will encourage consumption as less incentive to save and more incentive to borrow
Availability of credit: if more available, consumers able to borrow more easily to finance spending
What factors influence saving?
Interest rates: higher interest rates=more incentive to save due to higher reward from saving
Consumer confidence: save more when confidence low, such as fear losing job
Asset prices:when asset prices rising in value less need to save in other forms and consumption is likely to rise
Age of individuals: workers tend to save for retirement but pensioners running down their savings on goods/services
What are the types of investment?
Gross investment = spending on capital goods, before depreciation is taken into account
Net investment = spending on capital goods, after depreciation taken into account
depreciation = loss of value of capital goods over time
Gross investment - depreciation = Net investment
When is net investment positive/negative?
Positive= if gross investment is higher than depreciation. means the economy has more capital goods once depreciation has been taken into account, shift PPF outwards.
Negative = if gross investment is lower than depreciation. means less capital goods in the economy once depreciation taken into account, shift PPF outwards
What factors influence investment?
Rate of economic growth: high level of economic growth should mean employment high, more incentive to invest in capital goods as businesses are more confident of getting a return on their investment as consumers likely to consumer more goods/services as they are employed and earning income
Business expectations and confidence: high levels = more likely to invest such as when the economy is growing/consumers are spending. Businesses invest as they are more likely to make a return on this investment and perceived to be lower risk
Keynes’ and animal spirits: when business expectation are optimistic, many investors take risks which they would not take if expectations gloomy. Once they see others doing this, more likely to take risks herd behaviour
Demand for exports: higher demand, more incentive to invest and expand business by purchasing capital goods to maximize profits . Also have higher profits to invest/expand their business
Interest rates: low rates can encourage investment as makes borrowing cheaper and less incentive to save rather than invest
Access to credit: if banks willing to lend firms will have the finances to invest in capital goods
Government subsidies and regulations: gov could encourage higher business investment by increasing subsidies or reducing regulations in order to cut costs of production and incentive businesses to expand
Corporation tax: tax on business profits. If lowered, more incentive to invest as smaller amount of resulting profit will be taken as tax.
What are the main influences on government spending?
Fiscal policy:
gov may decide to change the level of spending in the economy when they change fiscal policy
Trade cycle: at different times in cycle there will be more or less money spent automatically on unemployment benefits. This is an example of an automatic stabilizer as spending will rise and fall on benefits to reduce the size of fluctuations in the business cycle
What is the link between gov spending and the multiplier?
Gov spending cause a multiplier effect.
e.g if gov implements a road building programme this would boost incomes of the employees involved
this income will be spent in the economy and will boost AD
What is net exports?
Value of exports minus imports
What is the impact of exchange rates?
SPICED = strong pound, imports cheap, exports dear
WPIDEC= weak pound, imports dear, exports cheap
What other factors influence net exports?
exchange rate
Uk incomes: as income rise, imports rise
UK inflation: if uk high rate of inflation, could increase costs for U. K firms and make them less internationally competitive. Reduce demand for exports and uk citizen buying cheaper imports
State of world economy:
If Uk export markets, e.g see economic growth rates fall, will reduce UK exports prospects and decrease net exports
What are evaluation points as to why UK exports may not rise?
Time to switch: consumers/companies may be stuck in contracts
Lack of UK manufacturing capacity: UK producers may lack the expertise or international competitiveness to export efficiently
What are the axis of aggregate demand curve?
Price level and Real GdP
Why does aggregate demand slope downwards?
The real balance effect: increase in average price level reduces the purchasing power of households so reducing qty of real output demanded
The international competitiveness argument: at higher prices, an economy is likely to export less as they are less competitive and are more likely to import - decreases AD
Interest rate arguments: at higher average prices, interest rate is likely to be higher meaning businesses will invest less and consumers will consume less too
What causes movement along the aggregate demand curve?
A fall in the price level leads to an expansion of AD
What causes a shift in aggregate demand?
An increase in AD leads to a shift outwards due to reasons such as higher net exports
What is aggregate supply (AS)?
Total supply of goods and service produced within an economy at a given price level and in a given period of time
What is short run aggregate supply (SRAS)?
Firms have little flexibility to vary their inputs. Money wages fixed and so in order to increase output in short run the firm needs to get more out of its existing factors of production. E.g paying existing workers overtime or paying a premium price for quickly delivery of raw materials
What is long run aggregate supply (LRAS)?
Firms have ability to change their inputs in order to increase output. e.g firm may decide to permanently hire more workers or purchase capital goods to raise output
- also time for money wages to adjust to price level in the economy such as wages rising to cover increased cost of living
What is the shape of the short run aggregate supply curve and why?
- slopes upwards
- if real output increase in the short run, firms will have to pay overtime or more money for quick delivery of raw materials
- so cost per unit rises
What are some of the costs of production for businesses?
Commodity prices
Energy costs
Wage costs
Indirect taxation
Government regulation
What causes movements/shifts in SRAS curve?
- fall in price level led to contraction in SRAS
- decrease in SRAS leads to shift inwards due to higher oil prices and other rises in costs of production
What is Classical Long-run Aggregate supply?
- classical economists believe that in the long run all markets will clear
- meaning that there can be no gap between actual and potential output in the long run and instead economy will always return to producing at its max potential level of output
- so change in overall price level does not affect aggregate output as economy always rapidly adjusts back to full employment
- makes it vertical
What is the the Keynesian Long-run aggregate supply curve?
- believe possible to have long run equilibrium where markets do not clear
- so there can be spare capacity in economy in long run
- disagree that wages will fall to clear labour markets when output below full employment
- believe that wages are sticky downwards and so there may be unemplyoment as firms cannot afford to take on more workers
What does the shape of the Keynesian LRAS supply curve show?
- when there is lots of spare capacity in the economy it is possible to increase level of real output with no resulting increase in the average price level, as costs will not rise substantially when ther is spare capacity in the economy; workers will not bargain up their wages in an economy with high levels of unemployment
- as spare capacity begins to be used up, rise in real national output will cause factors of production to rise, so price level rises with output. Workers begin to bargain higher wages and starts to be shortages in key raw materials as demand rises
- eventually economy reaches full employment where output cannot be increase as all factors of production being utilised
What causes movements along LRAS?
- caused by a change in the price level
- a rise in the price level can cause a movement along LRAS
What factors cause a shift in LRAS?
Changes in relative productivity:
higher productivity (better tech/workforce skills) cause increase in efficiency of factors of production
Discovery of raw materials: increase the quantity of ‘land’, boost productive potential as more goods can be produced
Net investment: if business investment exceeds depreciation lead to positive net investment. Lead to increase in LRAS and not only are out of date capital goods being replace but there is an additional increase in capital goods on top, allowing increased production
Demographic changes and migration: increase in size of working population will increase quantity of labour
Changes in government policy: may increase incentive to work by lowering unemployment benefits (reduce reward for not working)/lowering level of income tax (increase reward for working)
Education and skills: increase in quality of labour
Technological advances: better machinery = better quality of capital so more efficient
Competition policy: promote comp between firms as gives firms a greater incentive to be efficient in order to compete for higher profits/survive
What factors could increase both AD and supply?
Government spending on education: component of AD but also can improve productive potential of the economy in the long run by improving quality of labour
Changes in investment: component of AD but could also influence long-run aggregate supply as influenced by net investment
What is a negative output gap?
when actual level of GDP is below the productive potential of the economy
What is a positive output gap?
when the actual level of GDP is above the productive potential of the economy
What factors cause a change in SRAS?
Increase in costs of raw energy/materials
Decrease in costs of raw materials/energy
Appreciation/depreciation of exports/raw materials
Changes in tax rates
