Theme 2.2 Flashcards
(39 cards)
What is aggregate demand (AD)?
AD: The total demand in the economy. It measures spending on goods and services by consumers, firms, the government and overseas consumers and firms.
AD components are represented by the equation C + I + G + (X-M).
What are the components of aggregate demand?
Consumer spending
Investment
Government spending
Exports minus imports
What percentage of GDP does consumer spending account for in the UK?
Just over 60%
What is investment in the context of aggregate demand?
Business spending on capital goods, accounting for around 15-20% of GDP in the UK.
About 3/4 of investment comes from private sector firms.
How much does government spending contribute to UK GDP?
18-20%
What are exports minus imports?
The value of the current account on the balance of payments. A positive value indicates a surplus, whilst a negative value indicates a deficit.
This is the most insignificant part of AD.
What can the downward slope of the AD curve can be explained by?
1) Higher prices lead to a fall in the value of real incomes, so goods and services become less affordable in real terms.
2) If there was high inflation in the UK so that the average price level was high, foreign goods would seem relatively cheaper. Therefore, there would be more imports, so the deficit on the current account might increase, and AD would fall.
3) Higher interest rates will discourage spending, since saving becomes more attractive and borrowing becomes expensive.
What effect do higher prices have on aggregate demand?
They lead to a fall in the value of real incomes, making goods and services less affordable.
This contributes to a downward slope of the AD curve.
What is consumer spending?
This is how much consumers spend on goods and services. This is the largest component of AD and is therefore most significant to economic growth. It makes up just over 60% of GDP.
What is disposable income?
The amount of income consumers have left over after taxes and social security charges have been removed. It is what consumers can choose to spend.
What is the consumer’s marginal propensity to consume?
How much a consumer changes their spending following a change in income.
What happens when interest rates are lowered?
It becomes cheaper to borrow, reducing the incentive to save, thus increasing spending.
What is consumer confidence?
The level of confidence consumers have in the economy, influencing their spending behavior.
What happens if consumer confidence increases or decreases?
*If consumers have higher confidence levels, they spend more because they are less concerned about needing to save for future difficulties. This is affected by anticipated income and inflation.
*If consumers fear unemployment or higher taxes, consumers may feel less confident about the economy, so they are likely to spend less and save more. This delays large purchases, such as houses or cars.
What is the wealth effect?
When rising asset prices, such as houses, make consumers feel wealthier, leading to increased spending.
What is gross investment?
This is the amount that a firm invests in business assets that does not account for depreciations.
A depreciation is when something starts to lose value. If the depreciation in the value of the capital is greater than the growth in gross investment, there is a decrease in the value of capital in the economy and there is no economic growth.
What is net investment?
This is the actual addition to the capital stock of an economy, after depreciations have been considered.
Net investment = gross investment – depreciation.
What influences investment decisions?
1) Rate of economic growth
2) Business expectations and confidence
3) Demand for exports
4) Interest rates
5) Access to credit
6) Government regulations
Each factor can significantly affect the level of investment.
how does the rate of economic growth influence investment?
If growth is high, firms will be making more revenue due to higher rates of consumer spending. This means they have more profits available to invest.
how does business expectations and confidence influence investment?
*If firms expect a high rate of return, they will invest more. Firms need to be certain about the future, otherwise they will postpone their investments. Also, expectations about society and politics could affect investment.
What is the term animal spirits?
Keynes coined the term animal spirits when describing instincts and emotions of human behaviour, which drives the level of confidence in an economy
how does demand for exports influence investment?
This is related to the rate of market demand. The higher demand is, the more likely it is that firms will invest. This is because they expect higher sales, so they might direct capital goods into the markets where consumer demand is increasing.
how do interest rates influence investment
*Investment increases as interest rates falls. This means that the cost of borrowing is less and the return to lending is higher.
*The higher interest rates are, the greater the opportunity cost of not saving the money.
*Moreover, high interest rates might make firms expect a fall in consumer spending, which is likely to discourage investment.
how does access to credit influence investment?
*If banks and lenders are unwilling to lend, such as shortly after the financial crisis when banks became more risk averse, firms will find it harder to gain access to credit, so it is either more expensive or not possible to gain the funds for investment.
*Firms could use retained profits, however.
*The availability of funds is dependent on the level of saving in the economy.The more consumers are saving, the more available fund are for lending, and therefore for investing.
