Macro economics aggregate demand and supply

Which 2 groups does the economy consist of?

Firms and households

What do firms do

Manufacture goods and services, which form the national ouput

What do households do?

Supply factors of production (land, labour, capital) that firms need to create national output

What do households get in return for supplying the factors of production?

Firms pay households, who use this income to buy the goods and services produced by firms creating the national expenditure

How can the relationship between national income, output and expenditure be summarised

National output = national income = national expenditure

What 2 distinct types of movement make up circular flow of income?

Physical flow and monetary flow

What does physical flow include?

Real resources exchanged

From firms: goods and services

From households: labour, land, capital, enterprise

What does monetary flow refer to?

Money circulating in the opposite direction to physical flow .e.g. salaries for FOPs, spending on goods and services

What does the circular flow assume?

If households spend all their earnings and firms reinvest all revenues in production, the national output and income remain stable

Examples of injections into the circular flow

Exports, investment, and government spending

Exports

Sales of goods and services to foreign buyers bring in additional revenue

Investment

Spending by firms on new equipment or by others on assets like buildings

Government spending

Public expenditure on infrastructure, services or subsidies.

Examples of withdrawals from the circular flow

Imports, savings, taxes

imports

Purchases of foreign goods and services send money abroad

Taxes

Payments to the government that reduce available funds for spending

Injections

Add extra money directly to firms boosting the flow

Withdrawals

Remove money from the cycle, reducing the flow. These can occur from households or firms

When does economic equilibrium occur?

When total injections = total withdrawals

What’s the effect of greater injections that withdrawals

Higher expenditure than output, prompting firms to increase production so, national output, income and expenditure all rise

Effect of greater withdrawals than injections

This causes output to exceed expenditure, leading firms to cut back production. Consequently, national output, income, and expenditure all fall

The multiplier effect

As the injected money circulates multiple times, with portions spent and respect before leaking out, there is a ruling larger overall increase in national income than the initial amount injected

Multiplier formula

Multiplier = 1/ MPW

Total increase formula

Total increase = initial injection x multiplier Total increase

Income

Ongoing flow of money earned by households and firms such as wages or revenues

Wealth

Accumulated stock of assets owned by individuals or firms .e.g. cash savings, property like houses or items like vehicles.

Wealth in relation to the circular flow of income

Wealth acts as a reserve that is not actively part of the current circular flow but could enter it late

Fundamental difference between income and wealth in economic terms

income represents ongoing money flows while wealth represents accumulated assets

Formula for calculating aggregate demand

AD = C + I + G (X - M)

AD

Aggregate demand

C

Consumption

I

Investment

G

Government spending

X

Exports

M

Imports

Consumption

Total expenditure by households on goods and services, excluding business spending

What percentage does consumption usually make up of the aggregate demand equation?

66%

Saving

When income is not spent on consumption

How do income levels affect consumption

RDY boosts consumption, though the increase is usually smaller than the actual income rise (because people may save)

How do interest rates affect consumption?

Higher interest rates encourage saving over spending, make borrowing less appealing, discourage credit purchases and leave less RDY after loan repayments