AD and AS Flashcards
(19 cards)
What is the definition of AD?
What are the components of AD?
AD is the total final demand for goods and services in an economy at a given price level in a period of time
Consumption, Investment, Goovernment spending, exports and imports
What is the formulae of AD
AD = C + I + G + (X - M)
What is the relative significance of the factors of AD?
Consumption = 66%
Government Spending = 25-40% of AD
investment = 15%
Exports = 29%
Imports = 30%
What is the AD curve
The AD curve is the same as the demand curve for an individual market, but instead of showing the relationship between price and output, it shows the relationship between price level and real GDP. Like the demand curve, the AD curve is downward sloping. The X axis shows the general price level, and the Y axis shows real GDP
why does the AD curve slope downwards?
- The real balance affect - an increase in the general price level reduces purchasing power and thus reduce the quantity of real output demanded
- interest rates - when prices are low, interest rates are low
- X and M - Less or more internationally competitive
What is the difference between a movement and a shift along the AD curve
A movement along the AD curve is caused by a chang in the GPL, caused by inflation or deflation. A shift of the AD curve is caused by a change in any other variable, which is shown by a new line being formed next to the original ad curve. Again, as with demand, a shift to the right represents anincrease in AD and a shift to the left represents a fall in AD.
What is Consumption? Explain What factors influence it
Consumption is consumer spending on goods and services.
1. Asset prices - if asset prices are high, consumers will experience a positive wealth affect, as they feel better off. This will increase their confidence, so thus increase MPC and decrease MPS, as they have the security of their assets
2. Disposable income - Keynes argued this is the biggest determinent: as people earn more, they tend to have more money left over after spending on necesities, so consumption will tend to rise
3.Debt availability - if debt is widely available, lower income houe holds are more able to take out loans to finance large spending projects
4.interest rates - interest rates are the cost of borrowing and the reward for saving. If interest is high, it will be more expensive to take out loans, and much more beneficial to save. Thus, MPS will rise and people.
5. Confidence - If consumers are confident about the future outlook of the economy, they will spend a larger part of their income. conversly, if they feel insecure in their jobs, their MPS will rise as they want to save for unexpected consequences.
6.Taxation - If taxes are high, disposable income will fall, meaning consumption will fall
What is investment? What is the difference between gross and net investment?
Investment is the addition of capital stock to the economy, which increases the productive capacity of the economy by increasing the stock of capital available for production.
Gross investment is the total amount spent on investment, and ignores the impact of depreciation. Net investment is the actual spending on the addition of capital, this takes into account depreciation. N = G - D
What factors influence the rate of investment in the economy?
- Expectations about future demand - if the economy is growing and is expected to continue, firms will be confident that demand of their products will grow, so will wish to invest as they want to prepare for the future (international demand is also a factor). Animal spirits are key here - buisnesses need to be confident of the economic outlook so that they believe investment will be profitable. This will increase the Marginal Propensity to Invest
- Government incentives - governments may offer tax breaks or grantsto encourage investment. Levels of regulation are important aswell
- Interest rates - Most investment is done through borrowing. High interest rates
mean that borrowing is more expensive, so a business needs to be more confident of
good profits in order to cover the extra costs of borrowing. A rise in interest rates increases the opportunity cost of a business using retained profits as they are able to get higher interest
payments than before. - Retained profits - if reatined profits are larger, I.e because corp. tax is low, buisnesses will have higher retained profit so may increase investment
What is the accelerator effect?
What is the formula
The accelerator effect happens when an increase in national income (GDP) results in a proportionately larger rise in capital investment spending, as firms try to anticipate and match future economic growth.
I=α⋅ΔY
Where:
𝐼 is investment.
Δ𝑌 is the change in output or demand.
α is a constant that represents the “acceleration coefficient” (i.e., how sensitive investment is to changes in demand).
Thus, a larger increase in demand (Δ𝑌) leads to a proportionally larger increase in investment (𝐼)
What is government spending?
What influences it?
Money spent by the public sector on the acquisition of goods and provision of services.
* position in the trade/buisness cycle - governments may use Counter-cyclical fiscal policy counterbalance to smooth out the fluctuations of the business cycle by adjusting monetary policy During a recession, the government may increase spending or cut taxes to stimulate demand and boost economic activity. During a boom, the government may reduce spending or raise taxes to slow down the economy and prevent overheating.
* Fiscal Poicy - some governments may have different views on the ideal levels of government spending, so adjust taxation and government spending accordingly. Labour tend to tax and spend more than the tories
What is Net trade? what factors influence it?
Net trade is the total exports minus the total imports.
* real income - most imported and exported goods are normal goods, so an increase in the real income in the uk will tend to increase imports, and an increase in the real income of trading partners will increase exports
* exchange rates - This affects the relative price of UK goods and overseas goods. SPICEE (strong pound imports cheap exports expensive) and WIDEC (weak pound imports dear and exports cheap)
* state of the world economy - If the UK trading partners are having a boom, their consumers will tend to demand more UK exports, so theUK trade balance will increase
* degree of protectionism - The degree of protectionism will incluence the competitiveness of UK exports or foreign Imports
* non price factors - UK goods may be highly sought after due to changes in consumer preferences.
What is Aggregate Supply?
Aggregate supply is the total supply of goods and services produced within an economy at a given overall price level in a given time period.
What is the Short run AS curve?
The level of output firms in the economy would be prepared to supply in the short run at any given price
What is the distinction between the short run and long run?
The short run is a period of time where at least one factor of production is fixed. In the long run, all factors of prooduction are variable.
Why is sras upwards sloping?
In the short run, firms will have little ability to vary their outputs, as some factors of production will be fixed. if they want to increase output, they may need to do so by increasing the intensity of the utilisation of existing inputs, I.e by paying workers overtime. firms will pass this increased cost on to the consumer in the form of higher prices, increasing GPL.
What factors affect sras?
Anything that affects the costs of production - supply side shocks!
* wages, oil prices, raw material costs - if costs of inputs rise, it will be more expensive to produce the same amount of a good or service, so SRAS will shift to the left
* import prices - A weaker pound will lead to an increase in the price
of imports and this will cause SRAS to decrease as production becomes more expensive.
* Taxes - an important cost of production, will become more expensive to proudcue the same amount of output, so supply will shift to the left
What is Long run aggregate supply? What are the two different schools of lras.
In the long run, all factors of production can be changed.
Classica economists believe lras is verical, to represent the level of output the macroeconomy will always converge at. This is known the natural rate of output shown as Yfe). However, Keynesian ecnomists believe that an economy can produce at a level of output below Yfe in the long run. They believe lras bends, starting off as elastic and becoming increasingly inelastic, as at the elastic section, the economy is in a recession and there is mass unemployment of factors of production. therefore, the economy can increase output without experiencing any form of inflationary pressure.
What factors influence the position of LRAS
Q2CELL - the quality and quantity of the factors of production
* technological advances - provements in technology shift the LRAS curve to
the right, meaning more can be produced. This is because it will speed up
production, so more goods can be produced with the same amount of resources.
* Increased laboour productivity - the more productive labour is, the more output can be produced with the same amount of resources in the same time, shifting LRAS to the right
* Changes in education - a better trained workforce will increase efficiency
* competition - by breaking up monopolies, competition is increased, meaninng firms will have a greater incentive to invest into research and development to increase quality and decrease cost, increasing LRAS
* Migration - if net migration is positive, the workforce will continue to grow, so the productive capacity of the economy will increase
