Y12 Booklet 2: Aggregate Demand Flashcards
What is Aggregate Demand?
the total planned spending on goods/services produced in an economy
i.e. total expenditure
What 4 components make up Aggregate Demand?
Consumption
Investment
Government Spending
Net Exports
What is the formula for Aggregate Demand?
AD = C + I + G + (X-M)
What is consumption?
household expenditure on goods/services
What is investment?
firm expenditure on capital
What is government spending?
government expenditure in the economy
What is net exports?
exports - imports
(X-M)
When AD increases, what else must increase?
Expenditure, Output and Incomes
(E,O,Y)
What 3 areas are consumer spending divided into?
Durables
Non-durables
Services
Positives and negatives of increasing consumption
Positives:
- increased employment (more prod = derived demand for labour)
- increased output
Negatives
- demand-pull inflation (excess demand = shortages = price rise)
What can influence consumer spending?
1) real incomes and wealth
2) consumer confidence
3) availability of credit
4) interest rates
5) taxation
What influences consumer confidence?
- unemployment rates
- job security
- rate of economic growth
What is disposable income?
Income - costs
(Y - C)
What happens to consumption, when incomes increase?
increase
Who sets interest rates in the UK? What do they set?
Bank of England via “Monetary Policy Committee”
base rate
What is the base rate of interest?
the cost of borrowing for high-street banks
What interest payments will affect households?
- savings
- mortgages
- commercial loans
- credit card expenditure
How does an increase in interest rates affect spending, with regard to savings?
increased reward for saving, so more incentive to save, less spending
How does a decrease in interest rates affect spending, with regard to credit cards?
decreased cost of spending, so less incentive to save, more spending
What is APC/APS? What is the formula for this?
Average Propensity to Consume/Save
total consumption expenditure /
total disposable income
What is MPC/MPS? What is the formula for this?
Marginal Propensity to Consume/Save
change in consumption expenditure /
change in disposable income
APC + APS = ?
MPC + MPS = ?
1
What do APC/MPC mean?
the proportion of income which will be spent (consumed)
What do APS/MPS mean?
the proportion of income which will be saved
What is the multiplier effect?
|
when an initial increase in AD causes an even larger total increase in AD, because households spend more on consumer goods/services
e.g. government invests £10m into economy
# paid in wages to households
# / \
# save £4m (0.4) spend £6m (0.6)
# |
# paid in wages to households
# / \
# save £2.4m (0.4) spend £3.6m (0.6)
# |
# paid in wages to households
# / \
# save £1.44m (0.4) spend £2.16m (0.6)
£6m + £3.6m + £2.16m > £10m
total increase in NI > initial increase in NI
What is the formula for size of multiplier?
1 / MPS
What is the explanation of the multiplier effect?
1) initial increase in AD - e.g. govt. intervention
2) real NI increases
3) consumer expenditure increases (increase in Y = increase in C)
4) secondary increase in AD
What are the 2 types of investment?
Replacement Investment - replaces capital which has depreciated or been consumed (e.g. fixing machinery)
Net Investment - adds/decreases a country’s actual stock (gross investment - replacement) [e.g. buying more machinery]
What can influence investment spending?
1) price of capital/labour
2) technological advances
3) business confidence (i.e. “animal spirits”)
4) business cycle (boom or crash?)
5) interest rates
What is the accelerator effect?
when an initial increase in AD causes an even larger total increase in AD, because firms invest more in capital
What is the explanation of the accelerator effect?
1) initial increase in AD - so households have more money
2) firms at 100% technical efficiency need more capital to increase production to meet increased demand
3) firms invest in capital
4) secondary increase in AD
Positives and negatives of government spending
Positives
+ economic growth
+ improves equality
+ improves labour productivity (e.g. education)
Negatives
- higher taxation
- inefficient/over spending
- crowding-out investors + firms
When net exports decreases, what happens to AD?
decrease
What are some problems with exporting?
- different taxation laws
- uncertainty of market
- risk of too much pressure on supply chain
What is needed for short-run economic growth?
(i.e. a positive movement within a PPF)
increased real expenditure:
- increased AD
- increased short-run AS
What is needed for long-run economic growth?
(i.e. a positive movement of a PPF)
increased productive capacity:
- increased long-run AS
On a diagram of GDP, what is a peak called?
“boom”
On a diagram of GDP, what is a trough called?
“slump”
On a diagram of GDP, what is an increase called?
recovery/growth
On a diagram of GDP, what is a decrease called?
recession
What defines a recession?
2 consecutive quarters of falling GDP
What characterises a “boom”?
- high expenditure (E)
- high income (Y)
- high output (O)
- high consumer confidence
- demand-pull inflation
What characterises a “slump”?
- low expenditure (E)
- low income (Y)
- low output (O)
- low consumer confidence
How can a recession be solved?
increase AD
How can AD be increased during a “slump”?
Monetary Policy - decrease interest
Fiscal Policy - decrease tax
. - increase govt. spending
How does GDP generally move over time?
increases, with peaks and troughs
What is the AD curve?
What causes a shift in the AD curve?
change in
C+I+G+(X-M)
