Unit 2.2 Flashcards
Aggregate demand
the total demand for goods and services within a country. Measures spending on goods and services by consumers , firms, government and overseas consumers.
AD = C + I + G + NX
AD= (consumers) + (investment) + (government) + ( Net exports)
Consumer spending
Amount consumers spend on goods and services, this is the biggest contributor of AD- 60%
Investment
Investment/ spending from businesses, mostly from private sector businesses. Investment is spending which adds to the capital stock ie can only be used to increase output in the economy.
Government spending
This is how much the government spends on goods and services such as schools, hospitals, benefits, defence etc
NX ( exports - imports)
This is known as Net exports and is the value of the current account on the balance of payments ( we are in a deficit so this reduces AD)
Interest rate effect on AD
If I/r increase then investment and consumer spending decreases so AD decreases
Movement along the AD curve
If there is a fall in price level there is an extension in demand, if there is increase in price there is a contraction in demand.
Movement and Shift in the AD curve
If price changes in an economy (and nothing else) there will be a movement along the AD curve. If any of the components change then there will be a shift in the curve. Shift left ( inwards) if components decrease, Shift right ( outwards) if components increase
Reasons for shifts in the curve ( assuming price level is the same)
-Higher confidence levels amongst businesses will encourage more investment
-The wealth effect- most people in the UK own their own houses, so if house prices increase, they feel wealthier and so they spend more
-Bank of England decides to decrease interest rates. This lowers the cost of borrowing , decreases the incentive to save and lowers mortgage payments for homeowners (only for tracker(variable) rate mortgages, around 15-20% of Uk mortgage holders have these so the impact moderated) . All these can result in increased consumptions. Also increase investment but will appreciate E/R so stabliser.
-Decrease in tax rate means more disposable income which shifts AD to right
-An increase in government spending shifts AD to the right
-Weakening pound means we export more and shifts AD to right
factors affecting consumer spending
- Real disposable income
- Household wealth including house prices
- Unemployment / job security
- Interest rates paid on loans and savings
- Availability of credit finance
- Consumer confidence / animal spirits
propensities to spend and save
*Disposable income can be spent or saved
* Marginal propensity to consume (MPC)
* Marginal propensity to save (MPS)
* MPC + MPS = 1
* A rise in the marginal propensity to save implies a lower marginal propensity to spend
How lower interest rates can increase aggregate demand
A fall in interest rate on a property mortgage means that home buyers have less to pay each month paying the interest on a home loan(only for tracker(variable) rate mortgages, around 15-20% of Uk mortgage holders have these so the impact moderated) . This means they have a higher effective disposable income which can be spent on goods and services. Another effect of lower interest rates is usually to lower the cost of servicing a credit card to other types of borrowing. And it also reduces the incentive to save, especially if nominal interest rates on savings are below the rate of inflation. Through these channels, lower interest rates can be expected to lift consumer demand which is the largest component of AD. Cheaper loans might also lead to a rise in planned capital investment spending by businesses which is also a component part of AD.
Disposable income
The amount consumers have left over after taxes ; they can choose to spend or save this money.
Where does income for consumption come from
- Wages
-Pension - Investment
-The wealth effect - assets rising in value
Marginal propensity to consume
MPC: Refers to how much a consumer changes their spending following a change in income.
For individuals the MPC could be greater than 1 if they borrowed money to consume. For the economy as a whole the MPC is likely to be positive but less than .
= change in total consumption / change in income
Marginal Propensity to save
MPS: How much consumers change their saving following a change in income.
=change in total savings / change in income
MPC formula
Positive means a rise in income will increase consumption
Change in consumption/ change in income
Average Propensity to consume
APC: Measures the average amount spent or consumed out of total disposable income in an economy
Consumption (C) / Income (Y)
Other factors affecting C
-The availability and cost of credit - regulations on borrowing money can increase or decrease the level of consumption. Changes in i/r can make it cheaper / more expensive
-Expectations - If people expect a downturn in the economy to a period of slow growth they may save more
-Confidence - If consumers expect to be promoted in the future or are secure and know there are lots of jobs prospects
-Asset prices - changes in the value of shares or houses can influence spending decisions ( the wealth effect)
Wealth Effect evaluation
-Increase in house prices
-Decreases demand for houses, price out market
-Increased demand for rented properties
-Increased price of rented properties in LR (not SR bcs of contracts)
-Decreased disposable income, poorer memebers of society, with a higher MPC (as higher unmet needs, less saving).
Moderates/ decreases extent of wealth effect and decrease mobility of labour
(around 35% rent and 35% own)
Consumption Evaluation
Increased consumption increases Real GDP but:
-Demand-Pull inflation
-Time lags
-May increase imports
-Govt could increase VAT
-RIse in I/r
Time Lags In C
- A fall in Income ( Y ) might not immediately feed through to a fall in C
-Changing interest rates ( i/r ) won’t change C straightaway
Examples of Capital investment
-Robotics
-Integrated Plant
-Machine tools
-Infrastructure
-Software
-Logistics
Factors Influencing Planned business investment
-Actual and expected demand for goods and services
-Expected profits and business taxes
-Intrest rates + availability of business finance
-Business confidence i.e. animal spirits
Key points:
-Government can lift investment by lowering corporation tax or offering other tax incentives as part of their fiscal policy
-Planned investment tend to rise when firms expect rising demand and have limited spare capacity to supply goods and services.