2.2 Aggregate Demand Flashcards
What is AD?
the total demand for all goods/services in an economy at any given average price level?
How is AD calculated?
AD = Consumption (C) + Investments (I) + Government Spending (G) + Net Exports(Exports - Imports)(X-M)
What happens if AD increases?
economic growth occurs
What is consumption?
total spending on goods/services by consumers in an economy
What is investment?
the total spending on capital goods by firms
What is government spending?
total spending by the government in the economy
- includes public sector salaries, payments for provisions of merit and public goods etc.
What is are net exports?
the difference between the revenue gained from selling goods/services abroad and the expenditure on goods/services from abroad
What is the % that each component contributes to AD in the UK approx?
consumption - 60%
investment - 14%
government spending - 25%
net exports - 1%
Why is the AD curve downward sloping?3
- the interest rate effect
- the wealth effect
- the exchange rate effect
What is the interest rate effect?
- 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
What is the wealth effect?
- as average price increases
- the purchasing power of household decreases
- and AD falls
(and vice versa)
What is the exchange rate effect?
- 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
When does the AD curve shift?
when the components of AD experience a change
What is disposable income?
the only households have left from their salary/wages after they have paid their taxes and have received any transfer payments/ benefits
What can cause disposable income to change? 3
- if tax increases, disposable income falls
- if wages fall, then disposable income decrease
- if transfer payments to a household increases, then disposable income increases
What is the relationship between disposable income and consumption?
- consumption increases as disposable income increases
- consumption decreases as disposable income decreases
What is the relationship between savings and consumption?
disposable income can be saved or spent on goods/services (consumption)
- savings decrease, consumption usually increases
- savings increase, consumption usually decreases
What is the household savings ratio?
calculates households savings as a proportion of household income
- usually low when an economy its booming and full of confidence
What are some examples of influences on consumer spending?3
- changes to interest rates
- changes to consumer confidence
- changes to wealth
How do changes to interest rates influence consumer spending?
- 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
What is the relationship between consumer confidence as an influence on consumption?
- 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
How do changes to wealth influence changes in consumption?
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
What is investment?
total spending on capital goods by firms
- helps to increase the capacity of an economy
- increased capacity (PPF) leads to increased potential economic growth
What is depreciation?
the decrease in monetary value of a capital good over time
- replacing old capital goods does not necessarily increase capacity
