LS3- Aggregate Demand Flashcards
Aggregate demand
The total amount of spending on goods and services produced in an economy at a given price level over a given period of time
AD formula
AD= C + I + G + (X-M)
What happens when price falls on an AD curve?
There is an increase/extension in AD and therefore an increase in real GDP
What does the downward AD slope represent?
The fact that there is an inverse relationship between price level and the level of aggregate demand
The wealth effect
As the price level decreases, the purchasing power of income increases i.e. people are richer. Therefore, they’re more likely to spend money on goods and services in the economy since the marginal propensity to consume increases which will increase consumption.
The international trade effect
As the price level decreases, exports become more competitive and imports become less competitive. Imports would be less competitive as domestic goods and services are more competitive. Therefore, (X-M) increases.
What causes low interest and what does low interest stimulate?
As price level decreases, interest rates can be kept lower in the economy. This would stimulate higher consumption which stimulate higher investment (lower cost of borrowing).
When does AD shift?
When C, I, G or (X-M) change INDEPENDENT of the price level.
Determinants of consumption
- changes in consumer confidence
- interest rates- can decrease cost of borrowing as well as cut costs for those with variable rate mortgages, increasing their disposable income
- wealth- can increase marginal propensity to consume
- household indebtedness
- anticipated inflation
Define investment
The addition to the capital stock of the economy factories, machines, offices and stocks of materials, used to produce other goods and services.
What is it called when the value of a capital stock depreciates over time?
Depreciation of capital consumption
Difference between gross and net investment
Gross investment- investment before depreciation
Net investment- gross investment less the value of depreciation
Human and physical capital
Human capital- investment in the education and training of workers
Physical capital- investment in factories etc
