The Characteristics Of AD Flashcards
Components of AD and their relative importance
Aggregate demand is the total demand in the economy. It measures spending on goods and services by consumers, firms, the government and overseas consumers and firms.
AD equation
C+I+G+ (X-M)
Components of AD
-Consumer spending- How much consumers spend on goods and services. Largest component of AD and is therefore most significant to economic growth.
-Investment-Business spending on capital goods. It accounts for around 15-20% of GDP in the UK per annum, and about 3/4 of this comes from private sector firms. The other 1/4 is spent by the government on, for example, new schools.
-Government spending- how much the government spends on state goods and services, like schools and the NHS. It accounts for 18-20% of GDP. Transfer payments are not included in this figure, because no output is derived from them, and it is simply a transfer of money from one group of people to another.
-Exports minus imports-This is the value of the current account in the balance payments. A positive value indicates a surplus, whilst a negative value indicates a deficit. The UK has a relatively large trade deficit, which reduces the value of AD. This is the most insignificant part of AD.
Moving along the AD curve
-A fall in the price level from P1 to P2 causes an expansion in demand from Y1 to Y2.
-A rise in the price level from P2 to P1 causes a contraction in demand from Y2 to Y1.
-changes in the price level cause movements along the demand curve.
The downward slope of the AD curve can be explained by:
-Higher prices lead to a fall in the value real incomes, so goods and services become less affordable in real terms.
-If there was high inflation in the UK so that the average price level was high, foreign goods would seem relatively cheaper. Therefore there would be more imports, so the deficit on the current account might increase, and AD would fall.
-High inflation generally means the interest rates will be higher. This will discourage spending, since saving becomes more attractive and borrowing becomes expensive.
Shifting the AD curve
-The AD curve is shifted by changes in the components of AD (C,I,G, or X-M)
-A rise in AD is shown by a shift to the right in the demand curve (AD1 to AD2). This rise in economic growth occurs when any component of AD increases.
