Circular Flow of Income ( 3 ) Flashcards
What is aggregate demand?
- Total demand, or the total spending in an economy over a given period of time.
- Measures the spending on goods and services by consumers, firms, the government and overseas consumers and firms.
What is the AD formula?
C + I + G + ( X - M )
What are the components of AD?
- Consumer Expenditure
- Interest
- Government Expenditure
- Net Exports
What is consumption?
The total amount spent spent by households on goods and services, does not include firm expenditure
How does consumption affect AD?
- An increase in consumption will mean an increase in AD.
* A reduction in consumption will result in a reduced AD.
How are savings and consumption related?
- When consumption is high, saving tends to be low.
* High saving = Low Consumption.
What are the various factors affecting consumption/saving?
- Income
- Interest Rates
- Consumer Confidence
- Wealth Effects
- Taxes
- Unemployment
How does income affect consumption?
- As income increases, the consumption will rise.
- The rate at which consumption rises is usually lower than the rate at which income increases, because households tend to save more money
How do interest rates affect consumption?
• Higher interest rates lead to lower consumer spending, Consumers will save more to take advantage of higher rates, but also less likely to borrow money or buy things on credit because it is more expensive.
• Consumers may have less money to spend if interest rates on existing loans/mortgages increases.
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• Lower interest rates lower the cost of debt, this may encourage borrowing increasing consumer expenditure, also increases disposable income of households
• Lower incentive to save, consumer expenditure will be increases.
Why are interest rates not suitable for a fast gain in AD?
Time lags between change in interest rate and rise in AD.
How does consumer confidence affect consumer expenditure?
- Greater consumer confidence about the economy, and their own financial situation, the more they spend, and the less they save.
- Low confidence encourages saving, reducing consumer expenditure.
How does wealth affect consumer expenditure?
- A rise in household wealth will lead to a rise in consumer spending, and a reduction in savings.
- This occurs because consumer confidence will increase.
- If house prices rise faster than inflation, home owners will feel confident in their own finances.
How do taxes affect consumer expenditure?
• Direct tax increases lead to a fall in disposable income, so they spend less
• If indirect taxes increase ( VAT ), consumers will reduce their consumption.
A reduction in indirect taxes/direct taxes will lead to an increase in consumer spending.
How does unemployment affect consumer expenditure?
- When unemployment rises, consumers tend to spend less and save more.
- People in employment will save more, as consumer confidence falls ( fear of losing job )
- Fall in unemployment means more people have money to spend, and consumers are less worried about losing their jobs, so consumer spending increases.
What is the difference between investment and saving?
- Savings are made by households
* Investments are made by firms.
