7.2 Flashcards
reflationary policies
- policies aimed to stimulate the economy
- increase AD to increase real output and jobs
Equilibrium national income AD
- level of real output where AD=AS
- If AD or As curve shifts point of equilibrium NI will change
Economic shocks
Demand shock
Supply shock
Aggregate Demand
total planned spending for an economy’s goods and services at a given price level
Determinants of AD: Consumption
-Keynes: consumption is determined by disposable income (gross income-taxes+benefits)
- Friedman: consumption depends more on what households expect their income to be long term (permanent income)
- Money illusion: nominal pay increases make people feel wealthier (money wage)
- Consumer confidence: marginal propensity to save or consume
- Wealth: more = more consumption
- Wealth effect: ^
- Distribution of income & wealth: inequality lowers consumption: those with higher incomes have marginal propensity to save lower income have marginal propensity to consumer
- Rate of interest
- Expected future rate of inflation
Determinants of AD: Investment
- spending on capital goods
- To get increase in AD investment much be more than just replacing old capital; it needs to be positive net investment (increase in economy’s capital stock)
- Interest rates: higher = discourage investment
- Accelerator theory of investment
- Technological advances: Improved production methods leads to cost savings = greater profit
- price of capital equipment: law of demand means that if price of capital increases demand will decrease: investment falls
- Gov policies: fund R&D leading to more investment. Taxes will affect how profitable firms are; therefore their levels of investment.
Determinants of AD: Government Spending
- Welfare payments
- provision of merit goods (third party benefits)
- Provision of public goods (free rider effect)
- Interest payments on national debt
Determinants of AD: Net exports (X-M)
- SPICED: Strong £ Imports Cheap Exports Dear
- WPIDEC: Weak £ Imports Dear Exports Cheap
- Inflation rates domestic versus abroad: If our prices are going up slower than in other countries our products become cheaper. Vice versa if inflation higher in UK than abroad
- Brand image: exception to idea that people will always buy cheaper.
AD diagram & shifts
- the greater the shift in AD the greater the change in real output
-extent to which real output changes depends on steepness of AS curve - rise in price level + ceteris parabis = contraction in AD. vice versa
- If components of AD change, position of AD curve changes
- To understand if AD is growing to fast you need to consider how much supply there is & how fast that is growing
Demand-side shock: Global Financial Crisis
The collapse of the housing market and the subsequent financial crisis led to a significant decrease in consumer and business confidence. Banks faced liquidity issues, and there was a credit crunch, reducing the availability of loans for businesses and households.
- Decreased Consumer Spending: As households lost wealth due to falling home values and increased unemployment, consumer spending declined sharply.
- Business Investment Decline: Businesses, uncertain about the economic future, reduced their investment in capital goods and expansion projects.
- Government Intervention: Governments worldwide implemented expansionary fiscal policies and monetary measures to stabilize their economies.
Demand-side shock: The COVID-19 Pandemic
The global spread of the COVID-19 virus led to lockdowns, travel restrictions, and social distancing measures, significantly impacting consumer behavior and business operations.
- Plummeting Consumer Demand: With lockdowns and health concerns, consumer spending on non-essential goods and services sharply decreased.
- Supply Chain Disruptions: Disruptions in global supply chains led to a decline in production and exports, affecting businesses reliant on international trade.
- Increased Unemployment: Many sectors, such as hospitality, tourism, and retail, faced severe job losses due to closures and reduced demand.
- Government Stimulus: Governments responded with massive fiscal stimulus packages to support individuals, businesses, and the overall economy.
- Acceleration of Digital Transformation: The pandemic accelerated trends like remote work and e-commerce, reshaping the structure of certain industries.
