Unit 9.1 Flashcards
Aggregate demand
total amount of real output (real gdp) that consumers, firms, the government and foreigners want to buy at each possible price level, over a particular time period.
AD=C+I+G+(X-M)
Why does AD slope downwards
Wealth effect (C)
As price level decreases, the purchasing power of income increases (people are getting richer) leading to consumption increasing because people are richer
Trade effect (X-M)
As price level decreases, exports become more competitive and imports become less competitive. If exports become more competitive, greater demand, increased value of X and decrease value of M leading to increase AD, extension along AD curve.
Interest effect
AS price level decreases, interest rates can be kept low because most central banks will adopt a requirement to meet inflation target, so if inflation is low, interest rates are low. Lower interest rate stimulate higher consumption, high investment due to low borrowing costs, reduces value of exchange rate which boosts net exports, causing a expansion in AD.
When does AD curve shift
When C, I, G, or (X-M) change independent of the price level
Non price determinants that affect consumption (C)
Marginal propensity to consume (means willingness of household willing to spent extra money)
1)Level of real disposable income
can increase if income taxes have been cut, which increases disposable income which increases marginal propensity to consume leading to higher consumption
2)Interest rate/availability of credit
Lower interest rate, higher borrowing, lower incentive to save due to lower return hence higher consumption
3)Consumer confidence
Higher consumer confidence leads to higher marginal propensity to consume. Job prospects is higher means consumer confidence higher due to more security. Lower unemployment boosts confidence.
4) Asset prices
Asset prices such as houses and shares, if they go up they wil feel richer and will want to spend more money
5)Household indebtedness
Higher debt less spending henc less consumption
Non price determinants that affect Investment (I)
1) Interest rate
Firms usually invest in capital goods through retained profits or borrowing, therefore low interest rate will shift right ad due to higher investments
2)Business confidence
If expected profits are high. higher marginal propensity to invest, shifting ad right
If expected demand in high, higher mpi
3)Corporation tax
Higher corporation tax, lower the tax the higher the retained profit, therefore increasing profits that can be invested
4)Spare capacity
The greater the spare capacity the lower mpi to invest, if business operates close to maximum capacity, they will have incentive to invest
5)Level of competition
The higher the level of competition, where competitors keep investing in capital goods and machinery, firms need to react to that and keep up and also invest
Price of capital
The lower the price of capital goods, the higher the mpi.
BLIPSC
Non price determinants that affect government spending (G)
Changes in political priority:
governments have many priorities such as provision of merit goods and public goods, speninf gon pensions, salaries ect. It may decide to increase or decrease its expenditure in response to changes in priorities. Shifting AD right or left.
Non price determinants that affect Net exports (X-M)
If value of bracket increases, AD shift right, vice versa. Either exports could increase or imports decreases.
If value of bracket falls, AD shift to the left. Fall in exports rise in imports.
(make sur eto talk about export revenue coming in the country and import expenditure, that’s what measured in AD equation)
1)Real disposable income earned abroad
Higher income abroad will increase demand for exports, likewise w a recession less mp to buy exports due to lower income.
2)Real disposable income earned at home
If it is low (recession) less likely to buy imports, hence shifting AD right
3)Strong or weak exchange rates
Strong exchange rate wil shift AD left as imports will be cheaper and exports will be more expensive. Weak exchange rate, imports more expensive and exports less expensive, hence increasing demand for exports, shifting AD right
4)Inflation levels
High relative inflation levels compared to another country, exports will be less competitive, hence demand will be lower, shifting AD left.
