Components Of AE

Question 1

Aggregate expenditure

Answer 1

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

Question 2

Consumption definition

Answer 2

Consumption expenditure refers to household expenditure on goods and services

Question 3

Three types of consumption expenditure

Answer 3

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)

Question 4

Investment

Answer 4

Spending on new capital goods and additions to inventories

Question 5

What is a capital good

Answer 5

Any item of machinery that is used to assist labour in the production process

Question 6

Government expenditure- G1

Answer 6

Current spending: the goods and services consumed by government institutions and the wages and salaries paid to employees

Question 7

Government expenditure- G2

Answer 7

Capital spending: refers to spending on productive machinery and essential public infrastructure such as power and water supply, roads, railways and communication networks

Question 8

Net exports- exports

Answer 8

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

Question 9

Net exports- imports

Answer 9

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

Question 10

Why net exports averaged around -1% of Aus GDP

Answer 10

The negative value indicates that the aggregate value of imports exceeds the value of exports

Question 11

List of factors affecting consumption spending

Answer 11

Level of disposable income 
Cost of credit (interest rates)
Households current stock of wealth 
Consumer expectations 
Government economic policy

Question 12

Consumption factor- level of disposable income

Answer 12

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

Question 13

Consumption factor- cost of credit

Answer 13

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

Question 14

Consumption factor- households current stock of wealth

Answer 14

Households that hold real assets such a property or shares tend to feel wealthier when prices in those markets are high

Question 15

Consumption factor- consumer expectations

Answer 15

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

Question 16

Consumption factor- government economic policy

Answer 16

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

Question 17

List factors influencing investment expenditure

Answer 17

Perceived risk 
Rate of interest 
Profitability 
Business expectations 
Government policies

Question 18

Investment factor- perceived risk

Answer 18

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

Question 19

Investment factor- rate of interest

Answer 19

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

Question 20

Difference between nominal and real rate of interest

Answer 20

Nominal: current price of borrowed money
Real: takes the rate if inflation into account

Question 21

Investment factor- profitability

Answer 21

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

Question 22

Investment factor- business expectations

Answer 22

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

Question 23

Investment factor- government policies

Answer 23

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

Question 24

Factors influencing government expenditure

Answer 24

• 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

Question 25

List factors affecting net exports

Answer 25

``` Level of domestic and overseas economic activity Exchange rate Movements in the terms of trade Presence of tariffs, quotas Currency ```

Question 26

Net exports factor- level of domestic and overseas economic activity

Answer 26

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

Question 27

Net exports factor- exchange rate

Answer 27

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

Question 28

Net exports factor- movements in the terms of trade

Answer 28

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