2.2 Aggregate Demand Flashcards
(21 cards)
What is aggregate demand (AD)?
Total demand in the economy, measuring spending on goods and services by consumers, firms, the government, and overseas consumers and firms.
AD is represented by the equation C + I + G + (X-M).
What are the components of aggregate demand?
The components are:
* Consumer spending (C)
* Investment (I)
* Government spending (G)
* Exports minus imports (X-M)
Consumer spending is the largest component.
What percentage of GDP does consumer spending account for?
Just over 60% of GDP.
It is the largest component of aggregate demand.
What is the significance of investment in aggregate demand for the UK economy?
Investment accounts for around 15-20% of GDP in the UK, with about ¾ coming from private sector firms.
The remaining ¼ is spent by the government on capital projects.
How does government spending impact aggregate demand in the UK economy?
Government spending accounts for 18-20% of GDP and does not include transfer payments.
Transfer payments do not derive output and are merely a transfer of money.
What happens to aggregate demand when the price level falls?
There is an expansion in demand.
This is shown as a movement along the AD curve.
What is the relationship between interest rates and consumer spending?
Lower interest rates lead to increased spending as borrowing becomes cheaper.
Higher interest rates discourage spending by making saving more attractive.
Define disposable income.
The amount of income consumers have left after taxes.
It is the income available for consumption.
What is a consumer’s marginal propensity to consume?
The amount a consumer changes their spending following a change in income.
Consumers on low incomes are more likely to spend.
What is gross investment?
The total amount a firm invests in business assets without accounting for depreciation.
Depreciation reduces the value of capital over time.
What is net investment?
The actual addition to the capital stock of an economy after accounting for depreciation.
Net investment = gross investment - depreciation.
What influences government expenditure?
Factors include:
* The trade cycle
* Fiscal policy
Government spending can increase during recessions to stimulate the economy.
What is the effect of a depreciation of the pound on net trade?
Imports become more expensive and exports cheaper, potentially narrowing the current account deficit.
This is known as the SPICED effect.
What is protectionism?
The act of guarding a country’s industries from foreign competition through tariffs, quotas, and regulations.
It can reduce trade deficits but may lead to retaliation affecting exports.
What is the relationship between consumer confidence and spending?
Higher consumer confidence leads to increased spending.
Fear of unemployment or higher taxes can lower confidence and spending.
What is the marginal propensity to save?
The proportion of each additional pound of household income that is saved.
It complements the marginal propensity to consume, which together equal 1.
What is the wealth effect?
The phenomenon where rising asset prices, such as housing, make consumers feel wealthier, leading to increased spending.
This is particularly relevant in the UK where many own homes.
What are automatic stabilizers in fiscal policy?
Policies that automatically offset fluctuations in the economy, such as transfer payments and taxes.
They require no direct government intervention.
What factors can influence a firm’s investment decisions?
Factors include:
* Rate of economic growth
* Business expectations and confidence
* Interest rates
* Access to credit
* Government regulations
Firms invest more when they expect higher returns.
What is the impact of high interest rates on investment?
High interest rates discourage investment by increasing the cost of borrowing.
They also raise the opportunity cost of not saving.
What is the significance of the trade cycle on government expenditure?
Governments may increase spending during recessions to stimulate the economy and decrease spending during growth periods.
This affects the government budget deficit.
