3 - aggregate demand

aggregate demand

total demand for goods + services produced in the economy, at a certain price level, in a certain time period

equation

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

Aggregate Demand = Consumption + Investment + Government + Net exports

Factors affecting consumption: real disposable income

• Nominal income - income tax

• as income rises, so does consumption

why might more real disposable income not impact consumption?

• some may choose to save the extra money instead of spending

• some may not be confident in the economy

• higher savings mean consumption might not change

effective demand

• total demand for goods/services in an economy at a given time

• that is backed by the ability/willingness to pay

Factors affecting consumption: wealth

• when assets appreciate people spend more

• the wealth effect

• more spending confidence, higher credit score

• chances of factor incomes (e.g. getting rent as a landlord)

• can sell assets

wealth

stock of assets with monetary value 🏠🚗

why might not more wealth increase consumption?

• volatile asset prices

• illiquid assets

• selling (e.g. house) takes many steps and takes effort

factors affecting consumption: interest rates

• lower IRs means more borrowing

• its easier to pay back loans (esp good for lower class)

• variable mortgages (easier to repay)

• less reward for savings (less likely to save, instead just go and spend)

interest

cost of borrowing/reward for saving

why may higher interest rates not increase consumption

• people may not borrow if they think rates wont stay low

• net savers (e.g. pensioners). Less intrest, less disposable income, decreased consumption (if low savings)

• if people suspect a future recession they will continue saving

factors affecting consumption: inflation

• if inflation is suspected to be high in the future, people consume more now

• reduces value of money/disposable income

why might higher inflation not increase consumption

• if inflation is high/unstable consumption will decrease/fluctuate

factors affecting consumption: distribution of income

• wide gap between top rich people/bottom poor → income not distributed fairly

• gov uses a progressive tax system to redistribute

gini coefficient

• measure of inequality

• 0.34

why may distribution of income not affect consumption

• poorer people could save the increased income, instead of spending

• they wont buy big ticket items (things with lots of value)

• No spending confidence

factors affecting saving: real disposable income

• currently (saving ratio) 9.9%

• as income rises people have a higher potential to save

• high interest leads, better savings rewards, higher saving ratio

  • savings are a leakage so consumption/AD/GDP decreases, leading to recession

why may real disposable income not affect savings

• people dont have savings confidence

• they only think short term (myopia)

factors affecting saving: high interest rates

• opportunity cost of borrowing increases, easier to save instead

• consumption decreases

why may high interest rates not affect savings?

• unstable interest rates

• target saving goals (people only save up to a certain amt, e.g. to buy a house. Once target reached, they save less/consume more)

• people will save if they fear recession

factors affecting saving: range of financial institutions

• there are strong, trustworthy, readily available financial institutions (developing)

• NOT DONE