2.2 Aggregate Demand Flashcards
(27 cards)
What is aggregate demand?
Aggregate demand is the total level of spending in the economy at any given price
How is AD calculated?
AD=C+I+G+(X-M)
What is consumption?
(as part of AD)
Consumer spending on goods and services; it makes up about 60% of AD, so is the biggest part
How much of AD does consumption make up
60%
What is investment?
(as part of AD)
Spending by businesses on capital goods, such as new equipment and buildings as well as working capital e.g. stocks and work in progress; it makes up about 15-20% of AD. Most investment is by the private sector (about 75%) but there is also investment by the government.
What is government spending?
(as part of AD)
Spending by the government on providing goods and services, generally public and merit goods, both on wages and salaries of public sector workers and on investment goods like new roads and schools. Government spending tends to be around 18-20% of GDP.
(Transfer payments such as pensions and jobseekers’ allowances aren’t included in the figure as money is just transferred from one group to another)
How much of AD do net exports make up?
Around 5%
The UK has a large trade deficit, but this is a minor figure as (X-M) is the least significant part of AD
Why does the income effect mean the demand curve is downwards sloping?
As a rise in prices is not matched straight away by a rise in income, people have lower real incomes so can afford to buy less, leading to a contraction demand.
Why does the substitution effect mean the demand curve is downwards sloping?
If prices in the UK rise, less foreigners will want to buy British exports and more UK residents will want to buy imported foreign goods because they are cheaper. The rise in imports and fall of exports will decrease net exports so AD will contract.
Why does the real balance effect mean the demand curve is downwards sloping?
A rise in prices will mean that the amount people have saved up will no longer be worth as much and so will offer less security. As a result, they will want to save more and reduce their spending, causing a contraction in AD.
Why does the interest rate effect mean the demand curve is downwards sloping?
Rising prices mean firms have to pay their workers more and so there is higher demand for money. If supply stays the same, then the ‘price of money’ i.e. interest rates will rise because of this higher demand. Higher interest rates mean that more people will save and less will borrow and will also mean that businesses invest less, so AD will contract.
What is consumption?
Spending on consumer goods and services over a period of time.
What is disposable income?
Disposable income (Y) is the money consumers have left to spend, after taxes have been taken away and any state benefits have been added
What is the average propensity to consume?
APC is the average amount spent on consumption out of total income
How do you calculate MPC?
How do you calculate APC?
How to you calculate APS?
How do you calculate MPS?
When is the wealth effect experienced?
● When real house prices rise as owners now have more wealth so are more confident with spending as they know that if they go into financial difficulty they could borrow more against the house, since their house is worth more than their current mortgage
● Can also be experienced when share prices rise, people may sell some of their shares and spend the money or may be more confident in spending money they have as they know they have the shares to fall back on. Greater wealth will improve a consumer’s confidence and thus lead to greater spending.
What is investment?
The addition of capital stock to the economy i.e. machines and factories used to produce other goods and services. It is only seen as investment if real products are created so buying a share in a company would be saving but buying new machinery is investment
Gross and net investment
Gross investment is the amount of investment carried out and ignores the level of depreciation, whilst net investment is gross investment minus the value of depreciation
How does rate of economic growth influence investment?
In a growing economy, there will be higher levels of investment as businesses would be more confident about their investments and the higher demand would lead to a higher return rate on the investment. On top of this, a growing economy needs more investment in order to cope with the higher levels of demand
How can business expectations and confidence ‘Animal spirits’ affect investment?
When businesses are confident about the future and expect future growth, investment will increase as they want to prepare for the future. John Maynard Keynes used the term ‘animal spirits’ to describe the feeling of managers and owners of firms on whether their investment would be profitable
How can demand for exports influence investment?
If the world economy is booming, demand for exports is likely to increase and therefore exporting firms’ investment is likely to increase to cope with this extra demand. This will have a knock-on effect and encourage other firms to increase their investment.
