Aggregate Demand

Define Aggregate Demand (AD)

The total demand for goods and services produced in an economy at a given price level

What are the components of AD?

AD=C+I+G+(X-M). Consumption, Investment, Government spending, Net trade.

Roughly what % of AD do the elements make up in the UK

Consumption is 65%, Investment is 15%, Government spending is 20%.

Define consumption

Total spending of household on goods and/or services over a period of time by the consumers. Includes durable and non-durable goods

What factors affect consumption

MPC, wealth, consumer confidence, income tax, population, interest rates/availability of credit.

Define MPC

Marginal Propensity to Consume. The proportion of an extra income that households spend on consumption.

What is the usual difference in MPC between high and low income households?

High income households tend to have low MPC (because they save more) and low income households tend to have high MPC.

What is the wealth effect ?

The change in consumption following a change in asset prices. As people get wealthier they consume more, even though they may have no more income.

What happens to consumption if inflation is outside the 1-3% range.

It decreases. Low inflation - put off purchases until later. High inflation - reduced consumer confidence.

What is mortgage equity withdrawal ?

Borrowing money that is secured against your property in order to spend. It allows households to increase their spending when they have increased wealth.

Define Interest Rate

The percentage of you have to pay per year for borrowing / the percentage you receive per year for saving.

Why does a change in interest rates increase consumption?

Higher interest rates discourage borrowing and encourage saving. Lower interest rates encourage borrowing and discourage saving.

Define households saving ratio

The proportion of household disposable income that is saved.

Define investment.

spending by firms on capital.

What is the difference between gross and net investment?

Gross Investment before accounting for depreciation, Net Investment after depreciation of capital has been subtracted.

What factors affect investment?

Rate of economic growth, business expectations and confidence ('animal spirits')demand for exports, interest rates / access to credit, influence of government and regulations.

How does economic growth affect investment ?

Higher growth leads to higher investment.

How do business expectations and confidence affect investment ?

Higher confidence higher profit belief

How does access to credit affect investment?

More access to credit encourages borrowing, and hence investment.

How does demand for exports affect investment ?

More demand for exports means more investment and vice versa

How does the influence of governments and regulations affect investment ?

Corporation tax (tax on company profits) - cut in tax more money for investment Increase in subsidies - government pays for part of the cost of investment Gov cuts regulations (less rules eg less strict on planning permission) investment will become easier

What influences government spending (and how)?

Politics - Left wing parties tend to spend more, right wing parties tend to spend less.

What is a budget deficit ?

When government spending exceeds tax revenue. Adds to national debt

Which is a current account deficit ?

The value of imports is greater than the value of exports

What price factors affect exports and imports?

Exchange rates, Relative Inflation, Costs of Production

What non-price factors affect exports and imports?

Quality/reliability, After sales service, Fashions/trends, Innovation and branding.

How does a stronger currency affect exports and imports?

Exports decrease because goods and services are more expensive to other countries.

What are the reasons that AD is downward sloping?

Purchasing Power, Interest Rates, Exports / Imports Note: NOT Diminishing Marginal Utility or The Substitution Effect