T2: LS3 - Aggregate Demand Flashcards
Aggregate demand definition
The total amount of goods and service which consumers demand within an economy at a given price level over a set period of time.
What are the components of AD
Consumption, Investment, Gov spending and net exports
C+I+G+(X-M)
What causes contractions and extensions in AD?
W - Wealth effect
I - Interest Effect
T - Trade effect
Explain the wealth effect?
The wealth effect is the idea that as households experience appreciations in their asset values, increases in their income and wages
- more disposable income and they feel more rich
- Higher Purchasing power
- more Consumption of G&S
- increase in AD causing an extension (or vice versa)
Explain the Interest effect on AD
Interest effect: the idea that changes to interest rates can impact borrowing and inflation changing AD
- Higher interest rates occur
- Increases MPS (marginal propensity to save) and reduces MPC (marginal propensity to consume)
- less borrowing will occur
- reduces Investment and Consumption (C+I)
- contraction in AD (or vice versa)
Explain the trade effect on AD
Trade effect: the concept that changes to price impact net exports hence increasing or decreasing AD.
- Decreased prices and lower inflation
- Higher purchasing power
- Makes exports more competitive
- imports become less competitive and relatively more expensive
- Increased demand for exports and more domestic sales of G&S
- Increased AD
What causes shifts in Consumption (C)
A - Asset price
C - Confidence by consumers
I - Incomes
I - Interest
D - Debt levels
How do changes to asset price cause shifts in AD (inc)
Asset prices: refer to the valuation of a persons assets which impact their overall wealth
- increase in value of assets (appreciation)
- Increase in wealth levels
- increases consumers confidence
- Consumers feel more rich
- Increased consumption (C)
How does consumer confidence shift AD (inc)
Consumer confidence: refers to psychological beliefs of consumers in their confidence in their levels of income and economic growth.
- increased consumer confidence
- increases MPC (marginal propensity to consume)
- Increased Consumption (C)
How do income changes shift AD (inc)
Income: Income refers to the money or wages that an individual or firm receive in exchange for providing goods or services or factors of production.
- as incomes rise in the economy
- increases disposable income
- Increased purchasing power (if inflation is lower)
- Increased consumption (C) & AD
How do Interest rates impact AD (inc)
Interest rates: refer to the reward for providing money or capital for other economic agents to borrow.
- Lower Interest rates
- encourages more borrowing in the economy
- Increased expenditure
- increased consumption (C)
How do debt levels impact AD (dec)
Debt: refers to the sum of money that is borrowed over a certain period of time at an interest level that needs to be paid back
- unhealthy levels of debt within households
- increased costs and reduced disposable income
- Increases MPC (marginal propensity to save)
- reduced Consumption (C)
Define Investment in macroeconomics
Investment refers to the expenditure by firms in capital goods to help them increase their productive capacity.
How do you remember what causes Investment changes
P - Price of capital
I - Interest rates
C - Competition
C - Capacity (spare)
C - Business confidence
T - Tax (corporation)
How do interest rates impact Investment (inc)
Interest rates: one of two ways of financing investment (interest and retained profit)
- Low interest rates
- Low cost of borrowing
- High MPI (marginal propensity to invest)
- Lowers the hurdle (required rate of return to make an investment worthwhile)
- More investment
How does business confidence impact the level of investment (inc)
Business confidence: refers to the level of confidence by firms which is determined by the expectation of future profit and demand in the economy
- If confidence is high
- more likely to invest to meet level of demand in future or maximise on profit
How does Corporation tax impact levels of Investment
Corporation tax: A tax levied in a firms profits which are a direct type of tax.
- If corp tax is low
- higher levels of retained profit
- greater potential to invest organically (using retained profit)
How does Spare capacity change investment (inc)
- Low spare capacity
- Low FOP left to be used to increase productive efficiency
- more investment needed to increase capacity
How does the level of competition impact Investment (inc)
- High level of competition
- high investment in technology and changes from them
- prompt a firm to invest more to gain a competitive advantage and produce more to sell
- Increased investment
How does the price of capital increase investment
- Low price of Capital
- Lower proportion of costs
- more likely to invest more and higher MPI
What is the accelerator effect?
Accelerator effect: increased rate of real GDP and national income in the economy which causes a proportionally higher rate of investment spending
Define Government spending
Government spending refers to the total sum of money that a government uses to finance its activities and functions such as infrastructure and the public sector.
What is a budget deficit and surplus
Deficit: more government spending than tax revenue in a fiscal year
Surplus: more tax revenue than government spending in a fiscal year.
What are the different government spending reasons?
W - Welfare spending/ public wages
C - Capital spending (public)
C - Consumer spending (public)
D - Debt interest payments
How does current spending increase government spending
Current spending: refers to the maintenance of public services and payment of public sector wages
- increase in current spending
- Increase in government spending
- Acts as an injections
- increases AD
How does capital spending do to government spending and AD?
Capital spending: refers to the expenditure by governments on infrastructure and projects
- increased capital spending
- increased gov spending
- increased injections in the economy
- increase AD
How does Welfare spending impact AD
Welfare spending: refers to government expenditure on benefits and pensions.
- increased spending
- increased injections and gov spending
- increased AD
Debt interest payments and how they impact AD
These are withdrawals in the economy
- spending to reduce debt by paying off other countries
- reduce AD
Define net exports
Net exports: refer to the total quantity of goods and services which are produced in one economy and then sold abroad to another economy minus the value of imports.
What are the determinants of net exports?
D - Disposable income (home or abroad)
I - Inflation levels (home or abroad)
E - Exchange Rates
How does disposable income impact net exports (abroad…us)
- boom in income abroad
- more spending and MPM (marginal propensity to import) increases
- Higher net exports for us
- Boom in UK
- more demand for G&S
- Higher imports
- reduced AD
Exchange rates and their impacts on AD
S - Strong
P - Pound
I - Imports
C - Cheap
E - Exports
D - Dear
- lower AD
Weak exchange rates and impacts on AD
W - weak
I - imports
D - dear
E - exports
C - cheap
- increases AD
How does inflation impact AD
- relatively high inflation rates in the UK
- makes other products abroad look cheaper
- reduces export competitiveness and increases imports
