Theme 2 - aggregate demand Flashcards
Aggregate demand
Aggregate demand is the total level of spending within an economy over a given period of time
The formula for aggregate demand
AD = C + I + G + (X - M)
Why is the aggregate demand curve downward sloping
The aggregate demand curve show that as the price level increases, Real GDP decreases (national output)
what is the Income effect
The income effect is when an increase is when price level increases, consumer incomes do not increase immediately with this so can afford to buy less then current rates of consumption.
What is the substitution effect
If UK prices increased, then consumers will opt for cheaper alternatives as they can afford less
What is the real-balance effect
This is when a rise in price means that people’s savings will be worth less therefore they will have to save more in order for it to have worth.
What is the interest-rate effect
This is when wages have to be increase as a result of inflation. This will increase interest rates as a result of higher demand for money therefore decreasing consumption and increasing savings.
What causes a movement and a shift
A movement is caused by an increase/decrease in price and a shift is caused by another variable such as consumer confidence
What is the definition for consumption
a spending on consumer goods and services over a given period of time
What is the definition for disposable income
Money consumers have left to spend, after deductions such as taxations
Formula for MPC
Change in consumption/change in income
Formula for APC
total consumption/total income
What is meant by marginal propensity to consume
How much a person saves and spends from every extra pound earned
Why might a poorer person have a higher MPC than a richer person
Poorer people do not have enough disposable income to save and so majority of their income will be spent on basic necessities.
Influences that will impact consumer spending
Increase in wealth, increase in disposable income, Decrease in interest rates, Decrease in income tax, The age of the population (it is rational for a younger person to spend more), more credit, increase in consumer confidence.
What is the Keynesian consumption function
The Keynesian consumption function say that at low incomes, people will spend a higher proportion of their money because they have less to save. (John Maynard Keynes)
What do Keynesian believe the government should do
Decrease income tax and increase income benefits
What is the formula for the Keynesian consumption function
C = a +byd a = autonomous income b = marginal propensity to consume yd = Disposable income
What is the permanent income hypothesis
This was a hypothesis made by Milton Friedman. This said that people consume based on their future predicted income. This means that if income tax fell, consumption would not increase as a result of people knowing that this is temporary and it will increase again. A persons assets determines their permanent income e.g wealth
What is the formula for Permanent income
C = Kyp K = constant average and MPC Yp = Permanent income
What is the Life cycle hypothesis
The life cycle hypothesis states that at low incomes, people have a higher MPC and at high incomes, people have a high MPS. This means that for students it is rational to borrow to fund education and so they spend more however, at around 40, income is peak so you save more in order to have the same rate of income during pension. (Ando Modigliani)
What is the formula for Life cycle hypothesis
C = (w + Ry) / T w = wealth R = years until retirement Y = income T = remaining years of life
What is investment
Expenditure by firms on additional capital stock such as machinery
What factors increase the rate of investment
Lower capital good prices, technological advancements, Lower interest rates, increase rate of growth and animal spirits - consumer confidence.
