2.2 Flashcards
(13 cards)
What is AD?
The total planned expenditure in the economy at any given price level
What is the formula for AD?
AD = C + I + G + (X - M)
What causes movements and shifts along the AD curve?
Shifts - Change in any other variable
Movement - Change in price
Effects of AD
Income effect - As price falls, value of income rises so consumers buy more
Balance effect - Rise in prices means that people who have saved up will no longer be worth it so have to save more
Interest rate effect - If price inflation is low this will lead to a reduction in interest rates. Low interest rates means less incentive to save
What is the consumption function?
The consumption function is the relationship between consumption and other factors that determine how much a household consumes. The main factor is disposable income.
What is the formula for MPC?
Change in consumption / Change in income
What are factors that affect consumption?
Consumer confidence - when consumer confidence is high, consumption is higher. When consumer confidence is low about inflation, people will consume more before the effects of inflation come into play.
Wealth effect - Real house prices rise as owners have more wealth so are more confident with spending
Interest rates - If interest rates are high, prices for goods will be higher, so consumption decreases. Also increases mortgage repayments, so reduces consumption. People can also experience negative wealth effect
What is the Keynesian theory?
As incomes rise, households prefer to save more so average MPC declines. Higher income households have a larger proportion than low income households
What is investment?
The purchase of capital
-Capital is factories, machinery etc
What is gross and net investment?
Gross investment is the amount of investment carried out and ignores capital depreciation
Net investment = Gross investment - Capital depreciation
Factors affecting investment
Access to credit - When access to credit is high, interest rates are low so investment increases
Interest rates - When interest rates are low, investment increases because borrowing is cheaper
Keynes and business expectation - Keynes created “animal spirits” when confidence is low, households save more because demand and profits are lower than expected so production projects postpone
Rate of economic growth - when economy is growing, firms will need to increase investment to match an increase in demand
Demand for exports - demand increases so investment must increase which encourages other firms to increase investment
Factors affecting government spending
Fiscal policy - decisions about the government spending and taxes that depend on priorities of the government
Trade cycle - In a recession, government spending may increase to increase demand for jobs and support through benefits. During booms, government may decrease spending to reduce inflation
Factors influencing net trade
Exchange rate - A strong exchange rate means imports are cheap so exports are expensive. A weak exchange rate means exports are cheap so imports are expensive
Disposable Real income from abroad - If abroad countries earn more, they will import so other countries export more
Real income - When real income is high, there is an increase in imports as people tend to ask for more because demand increases, and the UK is unable to meet these needs so net trade decreases
Non price factors – Factors such as quality and design and marketing. If UK goods are of high quality, exports will be high because demand will increase and imports will decrease because people will want to buy more UK goods
State of world economy - If UK’s main export country is doing well, exports will remain high so net trade increases
Degree of protectionism - High protectionism means exports will decrease as it’ll be jarder for the UK to sell goods abroad
