Aggregate Demand

Define aggregate demand

The sum of all the demand for UK produced goods minus the goods and services imported from abroad

What are the 4 components of AD

Consumption, investment, government spending, net trade

Define consumption

Spending by households on goods and services

Define investment

The total amount spent on capital goods in an economy I.e. machinery, factories, etc.

Define government spending

Money that the government uses to buy goods and services, excluding ‘transfer payments’ such as child benefit and pensions

Define exports

Foreigners spending money in the domestic economy

Define imports

Households, governments and firms spending money on goods and services produced abroad (withdrawals from national income)

What is the relative importance of each AD component

Consumption: 66%, government spending: 21%, investment: 17%, net trade: -4%

What are the three reasons the AD curve is downwards sloping

The lower prices are the more people will buy, the real balance effect, at higher prices interest rates are likely to be higher to control inflation

What is the real balance effect

The total amount of spending in an economy will be approximately the same as economic agents have around the same amount of money to spend at different average prices (income = expenditure = output)

What are three reasons why consumers would spend more money

A change in income tax, increase in average wages + minimum wage, seasonal demand

What are three reasons why firms would spend more money

A change in interest rates, increase in consumption/ demand, the cost of each worker lowering (can employ more)

Define disposable income

The income paid that an individual receives after having paid any direct taxes and received any transfer payments/ benefits. It is the most important factor in determining the level of consumption

What area four main limitations of AD

Doesn’t show inequality, fails to count unpaid work, generally if AD is high so is CO2 emissions, the components are not all completely equal in their impact on the economy

Define marginal propensity to consume (MPC)

Measures the effect an increase in wages has on consumption/ spending

What is the equation for MPC

Change in consumption / change in income = MPC

What does an MPC of below 1 mean

As wages increase, spending will increase, but some will be saved. This means spending increases but not as much as wages increased

People on low wages are likely to have a higher of lower MPC?

Higher

Define average propensity to consume (APC)

The average amount spent on consumption out of total income

What is the equation for APC

Total consumption/ total income

Define marginal propensity to save

The increase in savings that comes from an increase in income

What is the equation of MPS

Change in savings / change in income

Define average propensity to save (APS)

The average amount saved out of income

What is the equation of APS

Total savings / total income

What are the three other influences on consumer spending

Interest rates, consumer confidence, wealth effects

What is the effect of interest rates on consumption and evaluate

High interest rates means higher incentive to save, meaning consumption decreases and savings increase. However, this isn’t the case for everyone, such as pensioners, as their money will be growing faster than normal

Explain the effect of consumer confidence on consumption and evaluate

Consumer confidence is the confidence individuals have about what the future holds, and how these expectations affect their decisions now. It is affected by the thought of inflation, recessions, interest rates, and taxation. However, this may be unpredictable and it is unlikely that the whole of society will interpret data in the same way. If responses are varied, impact is less significant.

Explain the impact of the wealth effect on consumption

The idea that as a person’s wealth increases, their consumption increases as well. The concept is based on the fact that if people have more confidence in their financial situation, they will be more willing and able to spend their money on goods and services.

Define depreciation

The decreases in monetary value of a capital good over time

Define capital output ratio

The amount of investment needed to produce a given amount of goods

What is the accelerator theory

The investment over a period of time is the change in real income x the capital ratio

What is the difference between gross and net investment

Gross investment is the total amount of investment carried out and ignores the value of depreciation. Net investment takes depreciation into account as well, so it is calculated as the gross investment minus the value of depreciation

What are the 7 influences on investment

The rate of economic growth, business expectations and confidence, Keynes and animal spirits, demand for exports, interest rates, access to credit, the influence of government and regulations

How does the government spending cycle look compared to the business cycle

Counter-cyclical

What are the two factors that mean government spending will inevitably increase during a recession

Tax revenues falls as incomes and consumption decreases, higher welfare spending as there are more individuals that qualify for benefits

What is the term for the tax and welfare systems and why

Automatic stabilisers, as they are automatic fiscal changes which smooth out the fluctuations as the economy moves through the business cycle

Define fiscal policy

The use of taxation and government spending to influence the economy and achieve macroeconomic objectives

What are the 6 influences on the net trade balance

Real income, exchange rates, state of world economy, degree of protectionism, non price factors, prices

Explain how an increase in real incomes in the UK may affect the net trade balance + evaluate

Real incomes increase will mean a rise in demand and the demand for imports will increase if the UK production can’t meet the rising demand. However, this will not be the case if the rise in real incomes is export led

How does a stronger pound affect net trade and evaluate

Imports are relatively cheaper and exports are relatively more expensive for our trading partners, therefore net trade decreases. The opposite is true for a weaker pound. It is all dependant on the PED of our imports and exports.

How does the state of the world economy affect net trade and evaluate

If the UK’s main trading partners are doing well, then there will be a higher demand for our exports in their domestic economy. This means net trade increases. However, it also suggest that their goods are more internationally competitive, and imports from their economy is relatively cheaper, meaning the demand for imports from them is higher and net trade decreases.

How does the degree of protectionism affect net trade and evaluate

Protectionism is an attempt to prevent domestic producers suffering from foreign competition, in the form of tariffs, quotas, etc. if there is high protectionism on UK exports in other countries, then our exports and net trade are likely to decrease. If there is high protectionism in the UK, then imports will decrease and net trade will increase. It is likely that the UK imposing strict tariffs will make other countries impose the same thing. However, protectionism is what is keeping net trade a relatively small component of AD, so the effect is not significant.

What are the main non-price factors affecting net trade (3 total)

Quality, design and marketing

How do non-price factors affect net trade and evaluate

All three non-price factors have the same effect on net trade. If the UK produced goods have better quality/ design/ marketing, then there will be higher demand for UK exports and lower demand for imports (as domestic consumers will prefer domestic goods), therefore better non-price factors in the UK will mean higher net trade. However, higher quality goods may suggest their cost of production is larger, and therefore the price is higher and consumers may prefer cheaper options.