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Macroeconomics Main > 04 Aggregate Demand > Flashcards

04 Aggregate Demand Flashcards

1
Q

What are the components of aggregate demand (AD)?

A

C + I + G + X - M

  • Consumption (C)
  • Investment (I)
  • Government Spending (G)
  • Net Exports (X - M)
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2
Q

A rise in the price level causes…

A

a contraction in AD

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3
Q

As fall in the price level causes…

A

an extension in AD

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4
Q

Define consumption.

A

Consumer expenditure on goods and services which includes the demand for ‘durables’ and ‘non-durables’.

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5
Q

Define savings.

A

The part of disposable income that households don’t spend on goods or services over a period of time.

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6
Q

Disposable income.

A

Households’ net income over a period of time.

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7
Q

Define the interest rate.

A

The costs of borrowing and the reward from saving.

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8
Q

What the determinants of consumption?

A
  • Level of disposable income
  • Interest rates
  • Consumer confidence
  • Asset prices
  • Household indebtedness
  • Availability of credit
  • Changes in income tax
  • Wealth
  • Share prices
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9
Q

How would a reduction in unemployment lead to a rise in AD?

A
  • It means that there would be a higher level of disposable income
  • Therefore consumers are likely to increase spending (consumption) on goods and services, increasing AD
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10
Q

How is the marginal propensity to consume calcuated?

A

Change in consumption/change in income

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11
Q

How is the marginal propensity to save calculated?

A

Change in saving/change in income

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12
Q

Define investment.

A

Spending by firms on capital goods, used to produce goods and services.

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13
Q

What are the determinants of investment?

A
  • Interest rates
  • Business confidence and profits - increased profits - more money for investment in capital goods
  • Corporation tax
  • Spare capacity
  • Level of competition
  • Price of capital
  • Consumer spending (the accelerator effect)
  • Subsidies
  • Availability of loans
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14
Q

Why are consumption and investment often positively correlated?

A

If there is a high level of consumer spending then this will boost investment as:

  • Consumption should increase profits for firms
  • There should be a boost to business confidence and investment becomes less risky
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15
Q

Define the Accelerator Effect.

A

When a rise/fall in AD causes a larger percentage rise/fall in investment. This can be positive or negative.
E.g.:
- Economic growth falls by 2%, investment falls by 5%
- Economic growth increases by 5%, investment will rise by more than 5%

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16
Q

Explain the accelerator effect.

A

In an industry where demand is rising quickly

  • Firms may respond initially by using their existing productive capacity more intensively or running down stocks finished products
  • If they expect high demand will be sustained - they may increased spending on plant and machinery, factories and new technology in order to increase their supply capacity
  • Cause an accelerator effect
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17
Q

What are some examples of the accelerator effect in action?

A
  • Investment to create extra capacity in cloud computing storage services
  • Investment in 4G mobile networks to meet rising household and business demand
  • Expanding the fleet sizes of growing airlines especially for low-cost short destinations
  • Capital investment in renewable energy as the balance of energy supply shift towards renewables
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18
Q

What is the negative accelerator effect?

A
  • When the rate of growth of demand in an industry slows than net investment spending by businesses often often falls
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19
Q

Define government spending.

A

The sum of all spending by the government.

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20
Q

Define the budget.

A

The Chancellor’s plans for taxation and government spending over the coming year.

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21
Q

Define budget deficit.

A

When the government spends more than it received in tax revenue in a given year i.e., G > T.

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22
Q

Define budget surplus

A

When the govt receives more tax revenue than govt spending in a given year i.e., G < T.

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23
Q

The budget is balanced when…

A

T = G

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24
Q

Define national debt.

A

The sum total of all previous debts the government has run up.

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25
Q

How does the government borrow money?

A

It sells bonds - promise to make payments on a certain date.

26
Q

Who do the government sell bonds to?

A
  • Individuals
  • UK banks and financial institutions
  • Foreign Governments, banks and individuals
27
Q

How does government bond selling work?

A
  • Government sells bond to individuals, banks, foreigners, etc.
  • Government use money to finance budget deficit
  • Government pays interest to bond holders at an agreed rate of interest in the future
28
Q

What are the benefits of a budget deficit?

A
  • Stimulates economic growth - G > T
  • Higher budget deficit might bring about a positive fiscal multiplier effect - final change in national income bigger than the increase in government spending and borrowing could stimulate private sector investment
  • A fiscal stimulus by more can help to prevent an economy falling into a deflationary depression
  • A deficit might reflect extra spending on capital projects - new schools, roads - and supply side policies (E.g. cuts in corporation tax) - might increase long run growth
  • Long term = larger deficit could be self-financing
29
Q

Why do Keynesian economists favour the active use of fiscal policy?

A
  • To manage aggregate demand
  • Stabilise output
  • Confidence and investment after an external economic shock
  • Fiscal policy via changes in the budget deficit might be more effective than monetary policy - e.g., if there is a liquidity trap
30
Q

What is a liquidity trap?

A

Occurs when a period of very low interest rates and a high amount of cash balances held by households and businesses fails to stimulate aggregate demand.

31
Q

What are the drawbacks of a budget deficit?

A
  • Adds to national debt thus increases the government’s debt servicing costs - taxes may need to higher
  • Might push up long term interest rates and thus crowd out private sector investment - to persuade people to lend it the money needs the government might have to offer higher interest on its bonds
  • Excessive government borrowing might lead to an over-heating economy - causes increased demand-pull and cost-push inflation
  • Risk of government failure from the state borrowing to pay for increased infrastructure and extra public services
32
Q

Name the 3 types of government spending.

A

Transfer spending, current spending and capital spending.

33
Q

What is transfer spending?

A

Payments from which the government does not receive anything back from in return e.g., universal credit.

34
Q

What is current spending?

A

Day to day spending on state-provided goods and services e.g., NHS and teacher salaries.

35
Q

What is capital spending?

A

Includes infrastructure spending such as new roads, hospitals and schools. This investment spending increases an economy’s PPF.

36
Q

Define net exports.

A

The revenue gained from exports (X), minus the revenue spent on imports (M).

37
Q

What are the factories affecting net exports?

A
  • Quality of exports
  • Exchange rates (via interest rates)
  • Income (in the UK and abroad)
38
Q

Define the exchange rate.

A

The value of one currency in terms of another.

39
Q

What are exchange rates determined by?

A
  • Interest rates
  • Relative inflation rate
  • Confidence
  • Competitiveness
  • Rate of growth
  • Demand and supply
40
Q

What does SPICED stand for?

A

Strong Pound Imports Cheap Exports Dear

41
Q

What does WPIDEC stand for?

A

Weak Pound Imports Dear Exports Cheap

42
Q

What happens when exchange rate rises?

A
  • Export prices increase
  • Imported goods cheaper
  • Foreign competition more effective in the UK
43
Q

What happens when exchange rate falls?

A
  • Export prices decrease
  • Imported goods more expensive
  • Foreign competition less effective in the UK
44
Q

A rise in interest rates will lead to a fall in…

A

aggregate demand as they reduce consumer spending and investment - it will reduce spending on imports and will improve the competitiveness of exports.

45
Q

Why does an increase in interests rates could a rise in the exchange rate.

A
  • Increase in interest rates (UK)
  • Rise in Exchange Rate
  • X fall, M rises, (X-M) falls AD falls
46
Q

What is hot money?

A

Hot money flows refer to capital flows moving to countries with higher interest rates and/or expected changes in exchange rates.

47
Q

Give an example of the hot money effect.

A
  1. Increase in UK interest rates
  2. Better return on UK saving accounts
  3. ‘Hot money flows’ in to take advantage of higher interest rates
  4. Increased demand for £ Sterling
  5. Appreciation in value of £ Sterling
48
Q

Explain the impact of a fall in UK income on net exports.

A
  1. Fall in income in UK
  2. UK consumers spend a lot on imports
  3. UK consumers have less money to spend on imports
  4. Fewer imports
  5. Rise in net exports
49
Q

Explain the impact of a rise in incomes abroad on net exports.

A
  1. Foreigners more likely to purchase UK exports due to higher income
  2. Likely increase in exports
  3. Rise in net exports
50
Q

Explain the impact of a fall in quality of imports on net exports.

A
  1. Less demand for imports
  2. Decrease in imports
  3. Rise in net exports
51
Q

What it is the only factor that will cause a movement along the AD curve?

A

Price level (i.e., inflation and deflation).

52
Q

When do shifts in the AD curve occur?

A

When there is a change in C, I, G or (X-M).

53
Q

Chain of analysis:

- How will increased house price impact AD?

A
  • Rise in house price
  • Positive wealth effect
  • Rise in consumption
  • Rise in AD
54
Q

Chain of analysis:

- How will interest rates rising in the UK from 0.25% to 1% impact AD?

A
  • Rise in D savings in UK banks
  • Inflow of ‘hot money’
  • Increase D£
  • Strong £ (SPICED)
  • Rise in M, fall in X
  • Fall in AD
55
Q

Chain of analysis:

- How will decreased incomes abroad coupled with a fall in the quality of UK exports impact AD?

A
  • Fall in D for UK exports
  • UK is going to sell fewer exports
  • Fall in exports
56
Q

What will the impact of the government cutting healthcare spending be?

A
  • Fall in G

- Fall in AD

57
Q

What will the impact of a fall in the sterling exchange rate against other currencies impact be?

A
  • WPIDEC
  • X cheaper
  • Decrease £D
  • Rise in X, fall in M
58
Q

What will the impact of a rise in the Marginal Propensity to Consume, due to a rise in consumer confidence, be an AD?

A
  • Increase in consumer confidence
  • Rise in consumption
  • Rise in aggregate demand
59
Q

Impact on AD if the government decreases the basic % rate of income tax from 20% to 18%

A

Rise in C therefore rise in AD - could increase the budget deficit.

60
Q

Impact on AD if there is a sustained fall in the real value of UK property prices.

A

Fall in AD due to wealth-effect - fall in C.

Macroeconomics Main (17 decks)

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