section 2 (ad) Flashcards
aggregate demand
total planned expenditure on real output produced within an economy in a given period
sums up to gdp
ad formula
ad = c + i + g + (x - m)
consumption
spending by households on domestically produced goods and services; the biggest component of AD (56%)
‘domestically’ meaning
produced in the UK
investment
spending on capital goods/stock in the economy (i.e. machinery, factories, technology, and spending on human capital)
net gov spending
gov expenditure less tax plus borrowing
balance of trade
net exports / exports-imports (usually negative)
y axis on ad curve
price level
because we are looking at the average price for all goods and services not just one product
x axis on an ad curve
real output
shows the total output of an economy using real gdp (or rno, etc.) measured by years (y1, y2, etc.)
why does ad curve slope downwards
real income effect
interest rate effect
the balance of trade effect
real income effect
as the price level falls, the real value of income rises and consumers can buy more of what they want or need
interest rate effect
at a lower price level, interest rates usually fall, and this can cause higher aggregate demand
the balance of trade effect
a lower price level in the uk will make uk goods and services relatively more competitive leading to higher exports = higher gdp and demand
what causes movements along the ad curve
changes in price level cause contractions/extensions
what causes shifts in the ad curve
the economy growing or shrinking (controlled by aspects of ad)
how do changes in ad impact the economy
they lead to short term changes in real gdp/output
demand side economic shock
economic shocks are unexpected events which have a large impact on the economy
demand side shocks mean it would see a large fall in ad
examples of demand side economic shock
covid
gfc
brexit
terrorist attacks
collapse in house markets
stock market crash
what factors determine consumption
disposable income
falling unemployment
real wage growth
gov policies (taxes)
interest rates
consumer confidence
the wealth effect
disposable income
the main source of household income is wages; disposable income is income after taxes meaning income that can be used for consumption
how do interest rates affect consumption
there is an inverse relationship between interest rates and consumption
savings
income that is not spent, sometimes called deferred consumption
savings ratio
the % of disposable income that is saved in an economy
savings ratio formula
savings ratio (%) = ( savings / disposable income ) x 100
how does change in saving impact ad
savings up - consumption down - ad down
savings down - consumption up - ad up
factors that determine savings
disposable income
levels of debt
interest rates
changes in welfare system
age of population
taxation on savings
consumer confidence
the wealth effect
how does borrowing impact ad
borrowing up - consumption up - ad up
borrowing down - consumption down - ad down
what factors affect borrowing
disposable income
interest rates
consumer confidence
levels of existing debt (high debt = harder to borrow)
age (the young borrow more)
investment
spending on physical capital (machinery, factories, technology, infrastructure) or human capital (education and training)
done by firms not households
what factors affect investment
interest rates
return on investment
business confidence
rate of technological progress
availability of credit
government policies
the level of spare capacity
the accelerator theory
accelerator theory
shows the effect of the rate of change in national income (real gdp) on investment
changes on national income will see a larger than proportional change in investment
why does accelerator theory occur
during a boom, firms produce more output to satisfy the increase in AD so full capacity is reached quicker with more need for replacement and capital stock for higher productivity (e.g. machines wear off quicker + need replacement when more productive)
during a recession, firms have spare capacity in stock, so stock/capital is used less so does not need to be replaced or upgraded
factors affecting net government spending
the economic cycle
political ideology
current level of gov debt (high levels = austerity measures)
the ability of gov to borrow
the multiplier
a change in ad leads to a larger than proportional change in national income (works also in reverse as a downwards multiplier)
the multiplier formula
multiplier = change in national income/ change in injection
marginal propensity to consume (mpc)
the fraction of an increase in disposable income you plan to spend
mpc formula
mpc = change in consumption / change in income
multiplier k formula (with mpc)
k = ( 1 / 1 - mpc )
