Topic 1.2 - Aggregate Demand Flashcards
What is aggregate demand?
Total demand for goods and services produced in an economy at a given price level, in a given time period
What are the components of AD?
C + I + G + ( X - M)
What is consumption?
Spending by households on domestic goods and services
What influences how much households spend?
Real disposable income Wealth Consumer confidence and expectations Rate of Interest Age structure of population Distribution of income Inflation
What influences how much households spend? Real disposable income
As real income rises, households and economies tend to spend more
However, some may be saved
Average UK disposable income = £25,000
What influences how much households spend? Wealth
Value of assets a household holds, stock of accumulated past savings (property)
Higher household wealth = more spending
Can be spent and used to borrow against
Results in greater consumer confidence
What influences how much households spend? Consumer confidence and expectations
Optimistic feeling about jobs and wages leads to increased spending
Important link to house prices - rising house prices generally lead to encourage consumer spending
What influences how much households spend? Rate of Interest
Consumption financed through borrowing
Fall in R.O.I usually associated with rise in consumer expenditure - cheaper to borrow, reduces incentive to save, more to spend when paying less interest.
What influences how much households spend? Age structure of population
Young and elderly spend a relatively high proportion of their income
What influences how much households spend? Distribution of income
Poor spend more than rich
Income/wealth not evenly distributed
What influences how much households spend? Inflation
Rising prices may cause people to hold off from current spending
What is the consumption function?
Relationship between consumer expenditure and disposable income
Position depends on other factors that affect how much households spend on consumer expenditure
Consumption function model
Evaluate the relationship between consumption and income, on the one hand…
Yes there’s a clear relationship between income and consumption
As income increases so does consumption
Evaluate the relationship between consumption and income, on the other hand…
Extent to which on increase in income will lead to an increase in consumption depends on proportion of additional income saved
Consumption often lower than increase in income, household may not respond to small change in income
Expectations and confidence in the future economy - will base spending on what will they expect will happen in future rather than current levels of income
Type of employment eg zero hours contracts - may be wary of any changes in income and increasing consumption due to flexible nature of contract
They may smooth out expenditure over a lifetime - borrow young, pay back when middle aged, save for retirement
What is investment?
Spending by firms on capital goods
Man-made aid to production (adds to capital stock)
Allows increased output of consumer goods and services in future
What is gross investment?
Total spent on capital
What is net investment?
Total capital spending - capital consumption ( replacement investment )
Why would a firm want to invest?
Higher profits from meeting higher demands
Expand capital stock to increase capacity
Improve efficiency through innovation/technological progress
Expand firm’s product range
Invest in new tech to remain competitive (international markets)
Benefits of investment
Increase productive capacity of economy by increasing capital stock of capital available for production
Capital stock provide a supply of housing services over a long period of time
What influences investment?
Rate of investment - lower rates mean cheaper borrowing, cheaper for firms to invest
Current profit levels - may use profit to invest
Expectations/confidence about future - confidence makes firms more likely to invest however, if inflation is high, increases uncertainty therefore reduces confidence/investment
Changes in Real disposable income - if income increases, firms invest to reach future demands
Advances in tech
What is the importance of expectations for investment and consumption?
Expectations formed by households and firms
Pessimistic views could result in lower AD
Households may save more, firms invest less when uncertain about future AD
Could cause/lead to recession, expectations can be self - fulfilling - firms find they’re justified in not investing
However, if optimistic, demand may increase, firms would invest, productive capacity of economy increases
What influences government spending?
Level of market failure and intervention
War, terrorist attacks, crime
Level of economic activity - unemployment/inflation
Political reasons - pleasing the electorate
What is trade?
Selling and buying goods and services from other countries
What are imports?
Purchase of good and services from abroad that leads to outflow of currency from the UK
What are exports?
Sale of goods and services to buyers from other countries leading to an inflow of currency to the UK
What factors influence the level of imports and exports?
Real disposable income at home Real disposable income abroad Domestic Price levels relative to price levels abroad Exchange rates Gov. Restrictions on free trade
Real disposable income at home - factor influencing level of imports and exports
Increased real disposable income will increase demand for imports
Decreased real disposable income will decrease demand for imports
Real disposable income abroad - factor influencing level of imports and exports
Demand for exports depends on UK trading partners
If there’s slow economic growth in trading countries, less will be exported so will impact AD in the UK
If there’s fast economic growth in trading countries, more will be exported
Domestic price levels relative to price levels abroad - factor influencing level of imports and exports
If UK inflation is high, exports will fall for UK and demand for imports will rise
If inflation is low, demand for exports will rise and demand for imports will fall
Exchange rates - factor influencing level of imports and exports
Increased UK exchange rate will increase demand for imports and decrease demand for exports
( weaker £ can sell more exports, stronger £ buys more imports )
Gov. Restrictions on free trade - factor influencing level of imports and exports
Increased restrictions such as tariffs would impact level of exports or imports
Aggregate demand curve definition and diagram
Relationship between level of AD and overall price level - shows planned expenditure at any given overall price level
What causes a movement along the curve?
Change in price level
What causes the curve to shift?
Changes in AD components (C + I + G + (X - M))
What will the effect be of the following on AD:
- households + firms more optimistic about economic prospects
- cut in income tax
- rise in interest rate
- fall in exchange rate
- rise in population size
Shift to: Right Right Left Right Right
