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Economics > 2.2 Aggregate Demand > Flashcards

2.2 Aggregate Demand Flashcards

1
Q

What is AD?

A

the total demand for all goods/services in an economy at any given average price level?

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2
Q

How is AD calculated?

A

AD = Consumption (C) + Investments (I) + Government Spending (G) + Net Exports(Exports - Imports)(X-M)

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3
Q

What happens if AD increases?

A

economic growth occurs

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4
Q

What is consumption?

A

total spending on goods/services by consumers in an economy

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5
Q

What is investment?

A

the total spending on capital goods by firms

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6
Q

What is government spending?

A

total spending by the government in the economy
- includes public sector salaries, payments for provisions of merit and public goods etc.

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7
Q

What is are net exports?

A

the difference between the revenue gained from selling goods/services abroad and the expenditure on goods/services from abroad

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8
Q

What is the % that each component contributes to AD in the UK approx?

A

consumption - 60%
investment - 14%
government spending - 25%
net exports - 1%

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9
Q

Why is the AD curve downward sloping?3

A
  • the interest rate effect
  • the wealth effect
  • the exchange rate effect
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10
Q

What is the interest rate effect?

A
  • At higher average price levels, there are likely to be higher interest rates.
  • higher interest rates reduce investments and are an incentive for households to save and vice versa
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11
Q

What is the wealth effect?

A
  • as average price increases
  • the purchasing power of household decreases
  • and AD falls
    (and vice versa)
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12
Q

What is the exchange rate effect?

A
  • As average price falls
  • interest rates are likely to fall too
  • lower interest rates lower the exchange rate
  • lower exchange rate causes economies goods/services are more attractive abroad and exports increase
  • thereby increasing real GDP
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13
Q

When does the AD curve shift?

A

when the components of AD experience a change

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14
Q

What is disposable income?

A

the only households have left from their salary/wages after they have paid their taxes and have received any transfer payments/ benefits

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15
Q

What can cause disposable income to change? 3

A
  • if tax increases, disposable income falls
  • if wages fall, then disposable income decrease
  • if transfer payments to a household increases, then disposable income increases
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16
Q

What is the relationship between disposable income and consumption?

A
  • consumption increases as disposable income increases
  • consumption decreases as disposable income decreases
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17
Q

What is the relationship between savings and consumption?

A

disposable income can be saved or spent on goods/services (consumption)
- savings decrease, consumption usually increases
- savings increase, consumption usually decreases

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18
Q

What is the household savings ratio?

A

calculates households savings as a proportion of household income
- usually low when an economy its booming and full of confidence

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19
Q

What are some examples of influences on consumer spending?3

A
  • changes to interest rates
  • changes to consumer confidence
  • changes to wealth
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20
Q

How do changes to interest rates influence consumer spending?

A
  • interest rates are set by government central bank that cause commercial banks to change the lending and saving rates they offer
  • changes cause changes to the level of consumer spending and savings
  • if interest rates increase a greater incentive to save occurs thus less consumption
  • if interest rates increase, the monthly repayment on any loan or mortgage increases. these higher loan repayments cause less consumption
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21
Q

What is the relationship between consumer confidence as an influence on consumption?

A
  • stronger the economy, the higher the consumer confidence
    • consumers feeling secure in their jobs are confident of receiving regular salary payments thus consumption increases and saving decreases
  • in a weakening or recessionary economy, confidence falls
    • consumers feel less secure in their jobs thus consumption decreases and saving increases
22
Q

How do changes to wealth influence changes in consumption?

A

if consumer wealth increases consumption increases
- rising property prices or share truces give consumer confidence to borrow moe money
increased borrowing leads to increased consumption

23
Q

What is investment?

A

total spending on capital goods by firms
- helps to increase the capacity of an economy
- increased capacity (PPF) leads to increased potential economic growth

24
Q

What is depreciation?

A

the decrease in monetary value of a capital good over time
- replacing old capital goods does not necessarily increase capacity

25
Q

What is gross investment?

A

the total amount of spending on capital goods
- spending includes replacing olds capital goods and purchasing new capital goods

26
Q

What is Net investment?

A

gross investment - depreciation
- provides information on the addition of new capital goods to an economy
- gives a better indication of the extra production possibilities that have been created through investment firms.

27
Q

Why do firms invest?2

A
  • if they feel confident that they will make a good return on their investment
  • decision is linked to the business objective of profit maximisation
28
Q

What are the 4 key influences on the decision by firms to invest?

A
  • rate of economic growth
  • interest rates
  • demand for exports
  • influence of government & regulation
29
Q

Why is the rate of economic growth an influence of investment?2

A
  • increasing growth sends a signal that higher output will generate higher profits
  • the faster the economic growth, the greater the urgency to invest
30
Q

Why are interest rates a key influence on investment?

A
  • most investment by firms is financed through business loans
  • decreasing interest rates encourage investment
  • mostly an inverse relationship between investment and interest rates
31
Q

Why is demand for exports a key influence on investment by firms?3

A
  • demand for exports increases, firms will likely invest to meet the global demand
  • demand for exports can increase if the exchange rate depreciates
  • goods/services are cheaper to foreigners
32
Q

Why is the intervention of government & regulation a key influence on investment by firms?2

A
  • government intervention can increase investment. e.g. subsidies
  • government regulation can decrease investment as It raises the cost of production for firms and can lower foreigners
33
Q

What are 3 other influences on investment?

A
  • business expectations and confidence
  • keynes & animal spirits
  • access to credit
34
Q

How do business expectations and confidence influence investment?

A
  • the longer a period of economic growth, the higher the confidence would be
  • if growth slows, future expectations of profits will decrease and investment decisions become harder
35
Q

How is Keynes & animal spirits influences on investment?

A
  • Keynes believed firms exhibit too much optimism in the good times and take too many risks
  • they run with the mood of the economy and make less rational investment decisions
36
Q

How does access to credit influence investment?

A
  • easier the access to loanable funds, the higher the levels of investment.
  • some developing economies have low access to credit and this holds back investment
37
Q

What is government expenditure?

A

influenced by the trade cycle
- spending linked to achieving policy aims
- can help on a local level or a national level

38
Q

What are the influences on government expenditure?3

A
  • the trade cycle
  • fiscal policy
  • age distribution of the population
39
Q

How does the trade cycle influence government expenditure? 1+3

A

decisions over government expenditure may be made in order to manage AD thus regulating the trade cycle
- in a recession, the government may increase spending in order to increase demand to reduce unemployment
- government spending also automatically rises during a recession as they have to spend more on unemployment benfits
- during booms the government may decrease spending to decrease demand and reduce inflation

40
Q

How does fiscal policy influence government expenditure?

A
  • some govt spending is fixed however this can be changed annually, set out in government budgets
  • the level of government spending depends on what they lay out in their fiscal policy
41
Q

What is fiscal policy?

A

the decisions about government spend and taxes, dependent on the priorities of the government

42
Q

How does the age distribution of the population influence on government expenditure?

A
  • ageing population leads to increased government expenditure
  • whilst a young population leads to increased spending education
  • the more dependent in the economy, the higher government spending tends to be.
43
Q

What is the net trade balance?

A
  • difference between the value of the exports and imports (X-M)
44
Q

What are net trade balance influenced by? 4

A
  • changes to real income
  • exchange rates
  • state of the world economy
  • degree of protectionism
45
Q

How does UK real income increasing effect exports & imports?

A
  • little effect on exports
  • consumers purchase more imports
  • trade balance weakens
46
Q

How does real income increasing abroad effect exports & imports?

A
  • foreigners purchase more UK products, exports increase
  • little effect on imports
  • trade balance strengthens
47
Q

How does UK £ appreciating effect exports & imports?

A
  • exports more expensive for foreigners, exports decrease
  • consumers money goes further abroad, imports increase
  • trade balance weakens
48
Q

How does UK £ depreciating effect exports & imports?

A
  • exports less expensive for foreigners, exports increae
  • consumers money is worth less abroad, imports decrease
  • trade balance strengthens
49
Q

How does the world economy booming effect exports & imports?

A
  • increased demand for UK exports
  • little effect on imports
  • trade balance strengthens
50
Q

How does the world economy depressing effect exports & imports?

A
  • decreased demand for UK exports
  • little effect on imports
  • trade balance weakens
51
Q

How does protectionism increasing effect exports & imports?

A
  • depends on retaliation measures from other countries
  • decreased demand for imports as they are more expensive
  • trade balance strengthens
52
Q

How does protectionism decreasing effect exports & imports?

A
  • likely to increase exports
  • increased demand for imports as they are less expensive
  • trade balance weakens

Economics (10 decks)

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