theme 2 topic 2 Flashcards
What is aggregate demand ?
The total demand for all goods/services within an economy at any given price over a period of time.
What happens as AD increases ?
Economic growth Increases
What are the 4 main components of AD ?
Consumption (C)
Investment (I)
Government spending (G)
Net exports (X-M)
What is the AD formula ?
AD = C + I + G + (X-M)
What is consumption ?
The total spending on goods/services by consumers within the economy.
What % of consumption makes up AD ?
66%
What does consumption include ?(5) and what do they all affect ?
- Real disposable income - after tax and NI
- Interest rates
- Consumer confidence (prospects and unemployment)
- Asset price (feeling of wealth)
- Level of indebtness
MARGINAL UTILITY
What is marginal propensity to consume ?
The proportion of an increase in income that gets spent on consumption.
What is investment ?
The total spending by firms on capital goods within the economy.
What does investment cause in the long run ?
An increase in the productive capacity of the economy, increasing long run economic growth.
Due to the quantity and quality of factors of production increasing.
What does investment cause in the short run?
It increases AD
What % of investment makes up AD ?
15-20%
What is most investment provided by ?
- The private sector (75%)
- The government
What does investment include ? (6) and what do they all affect ?
- Interest rate (availability and cost of credit)
- Business confidence (expected future profits and demand predictions)
- Corporation tax (retained profit as internal source of finance)
- Capacity utilisation
- Competition (internal and external)
- Capital goods process
MARGINAL PROPENSITY TO INVEST
What is government spending ?
The total amount of money spent by the government within the economy.
What is the majority of the government’s spending spent on?
Pensions
Healthcare
Welfare payments
This changes year on year as governments decide how much they spend
What is not included in the government’s figure ?
Pensions and JSA as money is transferred from one group to another
What % of government spending make up GDP ?
18-20%
What does government spending include ? (4)
- Current spending (public sector education and health including wages)
- Infrastructure spending
- Welfare spending (largest proportion)
- Debt interest payments (50 billion)
What is the net exports equation ?
Exports - imports
X - M
What are net exports ?
The difference between export revenue and the money spent on imported goods/services.
When does a minus figure occur ?
When imports are higher than exports as more money leaves the UK than comes in.
What % of the UK’s large trade deficit makes up AD ?
5%
What does government spending include ? (5) and what do they all affect ?
- Real disposable income rise abroad
- Real disposable income rise domestically
- Exchange rate (SPICE / WIDEC)
- protectionism at home and abroad
- Relative domestic inflation
MARGINAL PROPENSITY TO IMPORT
What is the price level on an AD curve ?
The averages of prices for all goods/services in the economy.
What is real national output ?
The output of the economy, taking into account inflation
What is the AD curve formula ?
Nominal (money) national output / average price level
What is the AD curve formula ?
Nominal (money) national output / average price level
Why is the AD curve downward sloping ? (4)
- Income effect
- Substitution effect
- Real Balance effect
- Interest rate effect
What is the income effect ?
As a rise in prices is not matched straight away by a rise in income,
people have a lower real income so can afford to buy less.
this leads to a CONTRACTION in demand.
What is the substitution effect ?
If prices in the UK rise, less foreigners will want those exports,
and more UK residents will want to buy goods from abroad (imports) as they are cheaper.
this leads to a decrease in net exports, so AD will contract.
What is the real balance effect ?
An increase in prices means that the amount people have saved up will no longer be worth as much,
and so will offer less security.
they will want to save more and reduce their spending, causing a contraction in AD.
What is the interest rate effect ?
A rise in prices means firms will pay workers more,
so there is a higher demand for money.
if supply stays the same, then the ‘price of money’ (interest rates) will increase to reduce this higher demand,
so people will save more and borrow less.
this means businesses will invest less.
AD therefore contracts.
What does a change in price levels lead to (on AD curve) ? and why ?
Movement along the curve.
Due to inflation/deflation.
What does an increase in prices lead to ?
CONTRACTION IN AD
What does a decrease in prices lead to ?
EXPANSION IN AD
Why does a shift along the AD curve occur ?
Occurs if there is a change in any of the components AD
An increase in any components of AD leads to ?
AD to AD 1
A decrease in any components of AD leads to ?
AD to AD2
What does a fall in the amount of consumption cause ?
A reduction in AD
What does LRAS stand for ?
Long run aggregate supply
What is LRAS determined by ?
The state of technology, productivity, factor mobility, and incentives.
What does the LRAS curve present ?
The normal capacity level of output for the economy.
It is assumed to be a vertical line (independent of prices)
What is the impact of an increase in imports ?
If importe increase, consumers and businesses are spending more on foreign goods/services instead of domestically produced ones.
This shift can lead to a decrease in overall demand for domestic output, and
reduces AD.
What is the effect of business investment increasing ?
It increases economic activity.
When firms invest in capital goods, it leads to job creation and higher production capacity,
increasing AD.
What is the impact of household savings decreasing ?
When they reduce their savings, this means they are consuming more,
this increases AD.
What is disposable income ?
The money consumers have left to spend, after taxes have been taken away and state benefits have been added.
What is disposable income affected by ?
Government taxation and wages
What does marginal propensity to consume show ? (MPC)
How much of a consumer’s extra income they spend, and how much they save.
Less than 1(but positive)
MPC formula
MPC = change in consumption / change in income
What is average propensity to consume ? (APC)
the average amount spent on consumption out of total income.
APC less than 1 (people save some earnings)
APC formula :
APC = total consumption / total income
What are the determinants of the level of consumption in a household ? (5)
- Confidence
- Disposable income
- Interest rates
- Levels of personal debt
- Levels of personal wealth
What happens when disposable income increases ?
Consumption increases (people can afford more)
It changes depending on tax and wage rates
What happens if interest rates fall ?
Consumption increases.
People save less and borrow more loans
People with variable rate mortgages see monthly disposable incomes increase.
What happens if levels of personal debt decreases (credit cards/loans) ?
Consumption increases
Less disposable income is diverted to repayments.
What happens if levels of personal wealth increases ?
People with higher levels consume more
they can borrow funds against the value of assets
e.g. their house
What happens if consumer confidence increases ?
During short/medium/long term economic prospects, if consumer confidence increases,
Spending will increase.
This is linked to their employment prospects or job security.
What is the relationship between saving and consumption ?
If consumption increases, savings decrease
What is marginal propensity to save ? (MPS)
How much an increase in income is saved.
What is average propensity to save ? APS
Average amount saved out of income
What happens with additional income ?
- It is saved
OR - It is consumed
MPS formula :
MPS = change is savings / change in income
APS formula :
APS = Total savings / total income
What are the 4 changes in household spending ?
- Durables (spending on household goods, vehicles, equipment)
- Semi durables (clothing,footwear,games)
- Non durables (food,drink,housing maintenance, fuel)
- Services (actual + imputed rentals for housing, transport, health)
What is the household final consumption expenditure ? (HHFCE)
HHFCE is an estimate of household spending.
What is said to happen with disposable income that isn’t used for consumption in economics ?
It is said to have been saved
What are other influences on consumer spending ?
- Interest rates
- Consumer confidence
- Wealth effects
What is consumer confidence ?
An economic indicator that measures the optimism of economic agents within the economy.
What are wealth effects ?
The Pigou effect occurs when consumers increase consumption due to an increase in the value of assets (house prices, shares).
This would increase output and increase employments.
What are the 3 determinants of saving ?
- Interest rates (if increases, the incentive to save increases as the reward is greater)
- Inflation (if prices rise fast, then the real value of saving is destroyed, so the incentive to save decreases)
- Confidence (if people are uncertain about the future, they will save more of their income in the event of wages cuts, wage freezes, or redundancy)
What is gross investment ?
The spending on capital assets (stocks) such as buildings, machinery, equipment.
These generate income in the future and increase the productive capacity of the economy (leading to economic growth.
What is investment ?
The spending of money on capital goods by firms in order to increase their productive possibility.
What is G7 ?
Group of 7 is an international intergovernmental economic organisation, consisting of 7 major developed countries which are the largest IMF- advanced economies in the world.
What is net investment ?
Gross investment - value of depreciation
What is depreciation ?
Takes into account how much value the capital assets lose over a period of time.
What are the 6 influences on business investment ?
- Rates of economic growth (accelerator theory)
- Interest rates
- Demand for exports
- Access to credit
- Business expectations and confidence (animal spirits)
- Government regulations
How do interest rates affect business investment ?
As firms need a bank loan to buy capital assets, an increase in interest rates may cause firms not to take loans.
Therefore, they are less likely to invest as it would mean an increase in fixed costs for interest rate repayments.
How does demand for exports affect business investment ?
An increase in demand for exports encourages firms to invest in capital assets to increase capacity to meet demand.
Exports increase due to exchange rates
How does access to credit affect business investment ?
Firms may want to borrow money to buy capital assets but may risk being turned down by banks.
Investment decreases when there is a high risk as there will be less access to credit and interest rates increase.
In recessions, it’s hard to access credit as banks are aware of the high risk, so they fear firms won’t pay them back.
How do government and regulations affect business investment ?
Businesses may be able to take advantage of government grants to complement their own investments.
This applies to new business start ups or businesses locating in an area of social deprivation.
Cutting corporation tax (tax on business’ profits) will mean businesses have more retained profit to invest and buy capital assets with.
Government regulations may mean firms can’t open up factories due to planning regulations, so less investment by firms.
How does the rate of economic growth affect business investment ?
Accelerator theory : as rate of economic growth increases, demand increases. This causes capital equipment to wear out and need to be replaced, so a firm’s investment will increase.
If there is demand for goods/services, firms need to invest in machinery to meet this increase in demand.
How do business expectations and confidence affect business investment ?
When firms are confident about the future and expect growth, investment increases as they want to prepare for the future.
The opposite happens if they are fearful of the future (investment decreases).
Keynes used the term ‘animal spirits’ to describe the feeling of managers and owners of firms on whether their investment would be profitable.
However, this is difficult to measure.
What is government spending ?
Spending by the central and local government on goods and services
E.g. healthcare, education
What are the 3 influences on government expenditure ?
- Trade cycle
- Age distribution of population
- Fiscal policy
What are the effects of an age distribution of population on government expenditure ?
Ageing population = increased government spending on pensions, social care…
Young population = increased government spending on education…
What are the effects of the trade cycle on government expenditure ?
Recession : economic growth is negative and government spending increases (more people unemployed, more unemployment welfare benefits payed by government)
Boom : economic growth is positive and government spending falls (unemployment decreases and so less needs to spend on welfare benefits). Also decreases demand and reduces inflation.
What is the trade cycle ?
The fluctuations in economic activity experienced by a country over a period of time. Consists of 4 phases (trough, peak, expansion, contraction)
What are the 4 phases of the trade cycle ?
- Expansion (economic growth boosts consumer confidence + employment)
- Peak (shows maximum output)
- Contraction (economic activity falls, causing job losses)
- Trough (lowest part before recovery begins)
Why is it important to understand the trade cycle ?
Helps economists and policy makers make informed decisions to stabilise the economy.
What is current spending ?
Public sector wages and maintenance of public services
Healthcare, education, emergency services
What is capital spending ?
Infrastructure and projects.
Why are transfer payments and pensions not included in the AD formula (G figure) ?
Money is just being transferred from one group to the next.
What effect occurs when an increase in government spending increase AD ?
Multiplier effect (stimulates the economy)
What is the fiscal policy ?
Changes in government spending or taxation by the government to influence the level of AD within the economy.
What type of policy is the fiscal policy ?
Demand side policy
What are the 2 types of fiscal policies ?
- Discretionary (through political changes or government action)
- Automatic stabilisers (policies used to offset fluctuations in the economic cycle that don’t require government intervention or regular policy change)
What are the effects of the fiscal policy on government expenditure ?
It can be either contractionary (used to decrease AD + occurs during times of economic prosperity) or expansionary (used to increase AD + occurs during times of economic turndowns)
Government spending is fixed from year to year, but they can vary what they spend each year, which is set out in their budget.
The level of government spending depends on what they lay out in their fiscal policy.
What is the net trade equation ?
Net trade = total exports - total imports
What are the 6 factors of net trade ?
- Real incomes
- Exchange rates
- State of world economy
- Degree of protectionism
- Non pricing factors
- Prices
How does real income influence net trade ?
As consumers real income increases, demand increases. The extent to which they increase depends on the marginal propensity to import.
However, as many UK goods are imported, increased demand means increased demand for imports.
Net trade decreases.
If an increase in real incomes is due to export - led growth, then net trade increases.
What is marginal propensity to import ?
The amount of additional income that households spend on imports.
How do exchange rate influence net trade ?
A strong pound makes imports cheap (more attractive to UK consumers) and exports expensive (less competitive and demand falls).
Imports RISE, exports FALL, net trade DECREASES.
however this depends on the elasticity of imports + exports.
A weak pound makes imports more expensive and exports cheaper.
Imports FALL, exports RISE, net trade INCREASES.
increases the revenue gained from exports and decreases the expenditure on imports.
How does elasticity affect imports + exports ?
more ELASTIC : a rise in price causes a fall in demand so the value of imports/exports.
more INELASTIC : a rise in price causes a small fall in the amount of imports/exports so the value of imports/exports rise.
If BOTH are elastic : a rise in the value of the pound leads to a fall in net trade.
How does the state of the world economy influence net trade ?
As global demand changes, so do exports and imports. A strong economy will import more goods and services to meet its needs, which can boost domestic consumption.
When an economy increases its productive capacity by using its resources effectively, it can supply more to the rest of the world.
If the UK’s main exports perform well, UK exports are likely to rise, improving its net trade balance.
The impact of the global economy on the UK depends on which countries are thriving and the trade relationships the UK has with them.
If real incomes increase in other countries, demand for the UK’s exports rises, leading to higher export revenues and a better net trade balance.
Which country has the biggest economy in terms of global imports ?
The USA
Which country has the biggest economy in terms of global exports ?
China.
They have used their low costs to supply.
As China sees economic growth, their costs will increase.
How does degree of protectionism influence net trade ?
As free trade expands (e.g., EU enlargement), new export opportunities arise. Protectionist measures limit exports by making it harder for foreign producers to sell in the UK.
If the UK increases protectionism, imports fall. However, if the UK imposes tariffs, other countries may retaliate, reducing UK exports.
It’s hard to impose tariffs on UK exports because foreign firms can sell cheaper, lowering demand and reducing export revenue.
What are examples of protectionist measures (4) ?
- Technical barriers
- Tarifs
- Quotas
- Government regulations
What is protectionism ?
An attempt to prevent domestic producers suffering from competition abroad.
How do non price factors influence the net trade balance ? (5)
Exports will increase if
- real GDP of other countries increases
- changes in taste and fashion leads to interest in products
- price inelastic exports likely to see a fall in volume sales but an increase in total revenue
- productive capacity increases , allowing for greater sales of a product
- product differentiation leads to greater demand for products
What are 2 non price factors ?
Quality and design + marketing
If the UK has higher quality goods, exports increase as foreign demand rises , and imports decrease as people in the UK will buy British goods.
Net trade increases.
How do prices influence the net trade balance ?
Increased prices of UK goods means they are less competitive.
Volume of exports fall
Volume of imports rise (affected by inflation rate)
Affected by the productivity of the UK (output per worker) as higher productivity leads to lower costs and so prices will be low.
The effects of changing prices on the value of imports + exports depends on PED
PED elastic = increased prices causes a fall in net trade
What is tax free allowance?
level of income you are allowed to earn before income tax is paid
What is business confidence determined by ?
- expected profits
- expected demand in the economy
What is national debt ?
Total stock of debt over time. (Accumulation of budget deficits)
What is a budget deficit ?
Government spending is greater than tax revenue in a fiscal year (borrowing in one year)
What is a budget surplus ?
Government spending is less than tax revenue in a fiscal year (borrowing in one year)
What is a fiscal year (months) ?
April to April
Multiplier equation
1/(1-MPC) answer x what the government injected
Why do governments tend to spend money in the economy ?
- Influence the macro economy
- Correct market failure
- Reduce income inequality
What are tarifs ?
Tax on imports
What are quotas ?
Restrictions on certain imports
What do government regulations do ? (In terms of net trade)
Increase safety standards to increase costs for importers
Which countries are in BRICS ?
- Brazil
- India
- China
- Russia
- South Africa
6.Iran - UAE
- Ethiopia
- Egypt
What is the wages equation ?
Wages x inflation
What is the circular flow of income ?
The flow of goods and services between households and firms and their corresponding payments in money terms.
What are the 6 factors that affect savings ?
- Level of real disposable income
- Interest rates
- Consumer confidence
- Range/Trustworthiness of financial institutions
- Tax incentives (ISA)
- Age structure of population (younger spend more than the middle aged population)
What is ISA ?
Individual savings account where you can have savings and earn returns on savings which are tax free up to a certain threshold.
How does a rise in taxation affect government spending, and in turn AD ?
An increase in tax raises government revenue, which allows government to increase spending.
This is based in the governments fiscal policy objectives:
If the government uses the additional tax revenue to increase spending, AD may rise.
If instead they use it to reduce national debt, AD may fall.
What are the potential indirect effects of higher taxation for consumers and business on AD ?
Higher tax on individuals can reduce disposable income, which can reduce consumer spending.
For businesses, they may be less confident to invest, as they face higher costs.
This can reduce AD.
