10.3 - the determinants of aggregate demand Flashcards
what is rate of interest?
reward for lending savings to somebody else (e.g. a bank) and the cost of borrowing
What are the factors that affect aggregate demand?
- interest rates
- level of income
- expected future income
- wealth
- consumer confidence
- availability of credit
- distribution of income
- expectations of future inflation
How does interest rates affect AD?
incresed interest rates increases saving and reduces consumption
How does level of income affect AD?
although absolute consumption rises, consumption falls as a fraction of total income, fraction saved increases
What happens if households attempt to save more? (Keynes, AD concept)
leads to overall income falling, less spending by households = less income earned by others.
Multiplier effect –> overall income falls
What is the paradox of thrift?
where an attempt to save more in an economy leads to lower income and lover overall savings (negative multiplier effect)
What is the life cycle theory of consumption?
a theory that explains consumption and saving in terms of how people expect their incomes to change over the whole of their life cycles
How does expected future income affect AD?
absolute income - assumes the most important influence on consumption is the current level of income
temporary fluctuations in income may not affect AD as much as some economists assume it would
How does wealth affect AD?
increased house prices, consumers consume more as wealth has gone up, this increases the amount of borrowing in the economy
What are the main forms of wealth in the UK?
houses and shares
What is an equity release?
taking out a larger mortgage on a house they live in and spending the money that they have borrowed
How does consumer confidence affect AD?
- high consumer confidence: households spend more and save less
- low confidence: save more spend less
closely linked to what government we have and how confident consumers are in the actions that the government are taking
What is availability of credit?
funds available for households and firms to borrow
What is credit crunch?
occurs where there is a lack of funds available in the credit market, making it difficult for borrowers to obtain finance and leading to a rise in the cost of borrowing
How does the availability of credit affect AD?
- available: and cheap (where interest rates are low…) consumption can increase
- not available: causes AD to fall dramatically as consumption has to rapidly decrease
What happened in the credit crunch in 2008?
because of debts in the US sub-prime (sector of the market that deals with mortgages for people with large debts and are risky) –> interest rates rose and credit supply wasn’t large enough
What is distribution of income?
the spread of different incomes among individuals and different income groups in the economy
How does distribution of income affect AD?
richer people have money and hoard, redistribution will cause more poorer people to have money and will consume more
How does expectations of future inflation affect AD?
uncertainty (due to inflation) can cause precautionary saving and reduced AD. They will also often put off purchasing large and expensive items such as cars or holidays
What do people buy to ‘hedge’ against inflation?
Land, instead of financial assets (stocks and savings)
What is savings?
decision by consumers to postpone their consumption
What is the equation for income?
income = consumption + saving
What is the equation for saving?
Saving = income - consumption
What is the personal savings ratio?
measures the actual/realised savings of the personal sector as a ratio of personal sector disposable income
