Theme 2 - Aggregate demand Flashcards
what is aggregate demand
the total demand for a countries goods and services at a given price level in a given time
equation for AD
C + I + G + ( X - M)
what does the wealth effect say
- When the value of assets such as property, stocks, or savings rises, individuals perceive an increase in their overall wealth
- People may feel more financially secure and willing to make significant purchases or spend on luxury items.
- Increased consumer spending stimulates demand for goods and services, which can drive economic growth
- and vice versa
when is there a shift in AD
when C,I,G,X, or M changes, nothing to do with price level
what is consumption
the total spending by households on goods and services in the economy
60 percent of ad
what is the MPC
the marginal propensity to consume is the willingness of a household to spend any extra income that they earn
what factors can affect consumption
- level of disposable income, eg if income taxes are cut, more disposable income to spend
- interest rates, eg a fall in interest rates, return on savings and cost of borrowing falls, increasing incentive for consumers to borrow and spend money
- availability of credit - if availability is low, it can reduce the impact of fall of interest rates
- consumer confidence - higher confidence = higher MPC
- Asset prices - the higher the asset prices, the richer people feel, increasing their likelihood of spending, higher MPC
- household indebtedness - famillies living with more debt are more likely to save money, in case things go bad, but families w less debt are more likely to spend
what can impact consumer confidence
- job prospects, if people believe they are likely to get promoted,their MPC may increase
- level of unemployment in the economy, people will feel more confident and secure in their job, making them spend more
Examples of asset prices
- house prices
- share prices
- bond prices
what are the types of government spending which can take place in the economy
- current spending - the spending on the maintenance of public services and public sector wages
- capital spending - spending on infrastructure projects, like railway lines
- welfare spending - spending on benefits and pensions, eg disability and child support, biggest part of govt spending
debt interest payments - when govt take out money out of the international bank, interest is added on that needs to be paid
how much money goes to debt interest payment
around 50 billion pounds
what is a budget deficit
when govt spending is greater than tax revenue in a fiscal year
what is a budget surplus
where govt spending is less than tax revenue in a fiscal year
what is national debt
the total stock of debt over time, the accumulation of budget deficits
what would cause AD to shift to the right
an increase in CIGXM
what will an outward shift of AD do
will raise national output at all price levels
what would an inward shift of AD do
reduce national output at all price levels
what does X and M represent in the AD equation
- export revenue coming into the country
- import expenditure
what factors can influence the level of net exports (X - M)
- real disposable income earned abroad, if there is a boom in the country abroad, the citizens are getting richer, their MPC to import goods likely to increase, Strong economic growth in the domestic country increases income and spending power, leading to higher demand for imports, the demand for exports likely to increase, shifting AD to the right, and vice versa
- real disposable income earned at home, boom in the UK, the MPC to import likely to rise, import expenditure likely to rise, shifting AD to the left, vice versa
- exchange rates - (SPICED and WIDEC), eg a strong exchange rate, cheap imports, demand for imports will rise and so will expenditure on imports, exports are more expensive, demand will fall, shifting AD left,revenue generated from exports will fall, vice versa
- protectionism from home and abroad, non tariff barriers, sanctions etc, may prevent trade with other countries, may reduce the revenue that can be generated through exports, strong protectionism abroad means X will be lower, shifting AD to the left and vice versa if there is strong protectionism of imports at home
- relative inflation rate at home - if the inflation rate at home is greater than that overseas, exports will be less competitive, demand for exports will decrease, the amount of export revenue will be lower, shifting AD to the left, vice versa
- import expenditure also increase if inflation is high, may be cheaper to buy things abroad as they can be imported
what does SPICED and WIDEC stand for
- strong exchange rate, imports cheap, exports dear
- weak exchange rate, exports cheap, imports dear
what is investment
when firms spend money on capital goods to increase their productive capacity
what factors can affect investment
- interest rates - low interest rates = lower cost of borrowing, firms have a greater incentive to borrow money and invest, reaching hurdle becomes easier, AD will shift right, vice versa
level of govt borrwing - crowding out
- Business confidence - if the expectations of profit and demand for the economy is high, businesses marginal propensity to invest likely to be high, to meet their level of demand in the future, vice versa
- Level of corporation tax -the lower the corporation tax, the higher the level of retained profit, the greater potential the business has to invest as they can use the retained profit to invest, AD shifts right, vice versa
- Spare capacity - if space capacity is high, there is no need to invest in things such as machinery as current ones are not being used up, AD shifts left, and vice versa
- level of competition - if competition is strong, businesses are more likely to invest, to get on the same level or better than their rivals, ad right
- price of capital - low price, investment is cheaper, marginal propensity to invest increases, shifting AD to the right and vice versa
what are interest rates
- cost of borrowing
- reward for saving
what is the hurdle
the required rate of return firms need for investment projects to go ahead
what is business confidence determined by
- expectation of future profit
- expectation of future demand in the economy
what is retained profit
the profit left after corporation tax has been paid
what is corporation tax
a tax on business profits
what is the accelerator effect
when there is an increase in rate of real gdp in the economy and that encourages further investment
what are savings
the part of disposable income which is not spent on goods and services in the economy
how do savings contribute to the increase or decrease in AD
- increased savings will decrease consumption, which is a variable in the AD equation, and vice versa
factors which can affect savings
- the level of real disposable income, higher income can increase both spending and saving
- interest rates, higher interest rates will encourage saving, as rate of return will be higher, increased marginal propensity to save, shifts AD left and vice versa
- consumer confidence - low consumer confidence because of something like fear of recession, encourages more saving and less spending
- range/ trustworthiness of financial institutions - in developing countries, banks may be less trustworthy, higher levels of corruption may decrease the marginal propensity to sav, increasing consumption
- education - if individuals know the benefits of saving, they would be more likely to save more
- tax incentives, eg ISAs - govt policies to encourage savings may increase marginal propensity to save, dont have to pay income tax
- age structure of population - younger people are likely to spend money and consume, older more likely to save their money, pensions etc
evaluation points for things than affect exports
- Exchange rate fluctuations can have immediate impacts on trade balances, but long-term effects depend on the elasticity of demand for exports and imports. For instance, if demand is inelastic, the volume of trade might not change significantly
- J-Curve Effect: In the short term, a depreciation of the domestic currency might initially worsen the trade balance before improving it, as contracts and trade adjustments take time
- if a trading partner is in a recession or contraction phase, its demand for imports decreases. The UK’s exports to this country may decline, leading to a reduction in net trade balance.
- Protectionist policies, such as tariffs and quotas, can lead to retaliatory measures from other countries, potentially harming exports and escalating trade wars
Explain the J curve
SHORT RUN
- After a currency depreciation, the prices of imports rise immediately,imports more expensive.
- Export prices in foreign currency terms may not adjust as quickly, causing the value of exports to remain relatively unchanged initially.
- As a result, the trade balance worsens because the higher cost of imports outweighs the unchanged value of exports.
LONG RUN
- Over time, consumers and businesses adjust to the new prices. Import volumes start to decline due to higher costs, and export volumes increase as foreign demand rises for relatively cheaper goods
- Eventually, the trade balance improves as the volume effects of increased exports and reduced imports outweigh the initial price effects. The increased competitiveness of the country’s goods leads to higher export revenues, and the reduced import demand lowers import expenditures.
What is disposable income?
Disposable income is the amount of income a household has left after paying taxes and receiving government transfers. It is used for consumption or savings.
What is the difference between gross investment and net investment?
Gross investment is the total amount spent on capital goods, including replacement and new investment.
Net investment is gross investment minus depreciation (the reduction in value of capital goods over time). Net investment represents the actual increase in capital stock.
What are Keynes’ “animal spirits” in the context of investment?
refers to the emotions and instincts that drive business decisions, especially investment. Confidence, optimism, or fear can strongly influence business investment, sometimes regardless of economic fundamentals.
What is the net trade balance
the difference between a country’s exports (X) and imports (M)
What is the distinction between actual and potential growth?
Actual growth refers to the increase in real national output (GDP) over time, measured by the actual output produced in the economy.
Potential growth refers to the increase in the economy’s capacity to produce goods and services over time, measured by the economy’s long-run trend growth.
What is the distinction between actual growth rates and long-term trends in growth rates?
Actual growth rates reflect short-term changes in economic activity, which can fluctuate due to factors such as business cycles, government policies, or external shocks.
Long-term trends in growth rates represent the steady increase in an economy’s productive capacity, driven by factors like technological progress and population growth.
problems with using the dollar to compare GDP
- inflation
eg : if 2 countries produce the same amount of cars, but one has higher prices,then that country is going to have a higher nominal GDP
