2.2 Aggregate Demand Flashcards
(24 cards)
What is aggregate demand (AD)?
Aggregate demand is the total planned spending on goods and services in an economy at a given price level and in a given time period.
What is the formula for aggregate demand?
AD = C + I + G + (X – M)
Where:
C = Consumption
I = Investment
G = Government spending
X – M = Net exports (exports minus imports)
What factors affect consumption?
Real disposable income
Interest rates
Consumer confidence
Wealth effects (e.g. rising house prices)
Availability of credit
Taxation
What is the marginal propensity to consume (MPC)?
The proportion of additional income that is spent on consumption.
Formula: ΔC ÷ ΔY
What is the savings ratio?
The proportion of disposable income that is saved rather than spent.
What is investment in economics?
Investment is spending on capital goods that will be used to produce other goods and services.
What is the difference between gross and net investment?
Gross investment includes all capital spending
Net investment = gross investment minus depreciation
What are the main influences on investment?
Interest rates
Business confidence
Access to credit
Economic growth and expected demand
Government policy (e.g. taxes, subsidies, regulation)
What determines government spending levels?
Fiscal policy objectives
Political priorities
State of the economy (e.g. recession = more welfare spending)
National debt and budget constraints
What factors influence net exports?
Exchange rates
Relative inflation rates
Real incomes (domestic and global)
Quality and competitiveness of exports
Trade barriers and protectionism
How does a depreciation in the exchange rate affect net trade?
Exports become cheaper
Imports become more expensive
→ Improves net exports, assuming demand is elastic
What causes a shift in the aggregate demand curve?
Any change in a component of AD (C, I, G, X – M) that is not due to a change in the price level.
What causes an increase in AD (rightward shift)?
Lower interest rates
Increased consumer/business confidence
Tax cuts
Higher government spending
Increased exports (e.g. due to depreciation or global growth)
What causes a decrease in AD (leftward shift)?
Higher interest rates
Higher taxes
Fall in government spending
Fall in exports
Strong exchange rate (reduces net exports)
Why does the AD curve slope downwards?
Wealth effect: Higher prices reduce real income → ↓ consumption
Interest rate effect: Higher prices → ↑ interest rates → ↓ investment and consumption
International trade effect: Higher domestic prices → ↓ exports, ↑ imports → ↓ net exports
What is the multiplier effect?
The process by which a change in an injection (e.g. investment) leads to a greater final increase in national income.
What is the formula for the multiplier?
Multiplier = 1 ÷ Marginal Propensity to Withdraw (MPW)
MPW = MPS + MPT + MPM
Where:
MPS = marginal propensity to save
MPT = marginal propensity to tax
MPM = marginal propensity to import
What is the marginal propensity to withdraw (MPW)?
The proportion of extra income not spent on domestic goods and services.
What is the relationship between the MPC and the multiplier?
A higher MPC leads to a larger multiplier, because more of the additional income is spent and re-spent in the economy.
What factors influence consumption?
Key factors include:
Disposable Income: Higher income increases consumption.
Interest Rates: Lower rates reduce saving incentive, boosting consumption.
Consumer Confidence: Optimism about future income encourages spending.
Wealth Effects: Increases in asset values can lead to higher consumption.
What factors influence investment?
Interest Rates: Lower rates reduce borrowing costs, encouraging investment.
Business Confidence: Optimism about future profitability boosts investment.
Technological Advancements: Innovations can spur new investments.
Government Policies: Tax incentives or subsidies can influence investment decisions.
What factors influence government spending?
Government spending is influenced by:
Fiscal Policy Objectives: Decisions to stimulate or cool down the economy.
Political Priorities: Allocation to sectors like healthcare or defense.
Economic Conditions: Recession may lead to increased spending to boost AD.
What factors influence net exports?
Exchange Rates: A weaker domestic currency makes exports cheaper and imports more expensive.
Global Economic Conditions: Strong foreign demand boosts exports.
Trade Policies: Tariffs and quotas can affect trade volumes.
Why does the AD curve slope downward?
Wealth Effect: Higher price levels reduce real wealth, decreasing consumption.
Interest Rate Effect: Higher prices lead to higher interest rates, reducing investment.
Exchange Rate Effect: Higher domestic prices make exports less competitive, reducing net exports.
