Components Of AE Flashcards
Aggregate expenditure
The sum of all spending on goods and services produced in the economy. AE is the equivalent of GDP when the economy is in equilibrium
Consumption definition
Consumption expenditure refers to household expenditure on goods and services
Three types of consumption expenditure
Expenditure on non-durable goods- consumed shortly after purchase, essential and fairly stable over time
Expenditure on durable goods- last for a longer period of time (3 or more years). Usually discretionary- can be postponed or brought forward, depending on individual household circumstances
Expenditure on services- intangible, provide transitory satisfaction of wants. Some essential (health, transport) or discretionary (entertainment, leisure)
Investment
Spending on new capital goods and additions to inventories
What is a capital good
Any item of machinery that is used to assist labour in the production process
Government expenditure- G1
Current spending: the goods and services consumed by government institutions and the wages and salaries paid to employees
Government expenditure- G2
Capital spending: refers to spending on productive machinery and essential public infrastructure such as power and water supply, roads, railways and communication networks
Net exports- exports
Exports occur when overseas evident a purchase goods and services produced in Australia
Spending on exports adds to AE on goods and services produced in Australia
Net exports- imports
Australian households, firms and governments purchase goods and services from overseas. Imports are a withdrawal from the circular flow of income, and thus reduce the aggregate amount of expenditure on Australia’s goods and services
Why net exports averaged around -1% of Aus GDP
The negative value indicates that the aggregate value of imports exceeds the value of exports
List of factors affecting consumption spending
Level of disposable income Cost of credit (interest rates) Households current stock of wealth Consumer expectations Government economic policy
Consumption factor- level of disposable income
Disposable income refers to the income households receive after tax.
There is a positive relationship between the amount households spend on consumption and their disposable income
But the proportion of income spent on consumption declines as income rises
Consumption factor- cost of credit
Interest rates represent the price of borrowed money (cost of borrowing). Low interest rates have a positive effect on household spending for two reasons:
- interest payments represent a smaller slice of disposable income when interest rates are low
- the opportunity cost of consumption falls
Households are faced with two choices- spend or save their income. Saving is less attractive when interest rates are low, because holding surplus funds in interest-bearing deposits offer a larger rate of return
Consumption factor- households current stock of wealth
Households that hold real assets such a property or shares tend to feel wealthier when prices in those markets are high
Consumption factor- consumer expectations
Expectations are the positive or negative sentiments that people hold about the state of the economy
Consumer sentiment has a greater impact on households intentions to purchase discretionary items
Consumption factor- government economic policy
RBA administers monetary policy using ‘cash rate’. If he cash rate rises, higher interest rates flow through other financial markets. Meaning households have less spending power
The commonwealth government is responsible for fiscal policy- using the government spending and taxing power to influence household spending decisions
List factors influencing investment expenditure
Perceived risk Rate of interest Profitability Business expectations Government policies
Investment factor- perceived risk
Investment decisions concern the future- involving risk.
Investment rises and falls according to the perceived risk which the future entails. Many factors influence risk- political decisions, international events and changes in consumer sentiment
Investment factor- rate of interest
Interest rates and the level of investment expenditure are negatively related
Interest rates represent the price of borrowed money so when rates rise, so do the repayments for capital items purchased with borrowed funds
Interest rates represent the opportunity cost of money. Firms have the choice of using retained profits for new investment or some alternative purpose. The opportunity cost of investment increases when interest rates are high
Difference between nominal and real rate of interest
Nominal: current price of borrowed money
Real: takes the rate if inflation into account
Investment factor- profitability
Many firms retain a portion of their profits for expansion- build new premises or buy new equipment
When economic conditions are challenging and profits low, firms may tend to run down capital equipment over a long period of time
Investment factor- business expectations
What businesses think about the current level of economic activity and forecasts for the future. Formed as a result of current economic events
A downturn in the level of business confidence could result in a reduction in planned investment
Investment factor- government policies
Fiscal and monetary policies affect investment decisions because they affect cost and expected returns
Taxing the earnings of an industry can change the risk/reward relationship in that sector
Tax incentives may attract funds to an industry. The record of the government in achieving key macroeconomic objectives also helps to foster a positive environment and encourage business confidence
Factors influencing government expenditure
- discretionary changes in according with government policy objectives eg. Social policies, health and education
- automatic changes due to the business cycle
- can be used to stabilise macroeconomic fluctuations
- economic factors are not considered central to government consumption and investment decisions
List factors affecting net exports
Level of domestic and overseas economic activity Exchange rate Movements in the terms of trade Presence of tariffs, quotas Currency
Net exports factor- level of domestic and overseas economic activity
Overseas demand for Australian commodity exports fluctuates according to regional and world economic conditions
Domestic levels of economic activity influence Australians’ propensity to import
Aus imports are relatively elastic with respect to GDP
Net exports factor- exchange rate
When AUD rises in value, domestic residents can buy more units of other currencies and overseas residents can buy less units of the Australian currency
Australian exports become less competitive in overseas markets. Buyers of imports find they are cheaper and thus makes them more competitive against domestically produced items
Appreciation of the currency will therefore have a contractionary effect on AE, decreasing net exports
If AUD depreciates against other currencies the price of Aus exports falls for overseas buyers, but import prices increase
This has an expansionary effect on the economy and net exports will increase
Net exports factor- movements in the terms of trade
A rise in Aus TOT tends to increase Aus net exports and has an expansionary effect on the economy
A fall in the TOT sees the prices received for exports fall relative to the prices paid for imports, in which case exports receipts are likely to fall
