4.2.2.A - Aggregate Demand

Aggregate Demand

The total amount of goods and services that economic agents are willing and able to buy at any given price level in an economy over a given period of time.

Components causing shift of AD

INCREASE IN ANY OF COMPONENTS = INCREASE IN AD

- Consumption = Total planned spending by INDIVIDUALS AND HOUSEHOLDS on consumer goods and services produced within the economy.

- Investment = Total planned demand for capital goods (man-made aids to production) by FIRMS

- Government Spending = Spending by the central and local government on goods & services.

- Net Exports (balance of trade) = X-M

Why AD is Downward Sloping (3 effects)

- Wealth Effect = Rise in price level --> Decreases amount of goods & services that wealth can buy --> C&I

- International Trade Effect = Rice in price level --> Makes country's products less internationally price competitive --> Households & firms buy more from foreign producers, Foreign households & firms buy less of our exports --> X-M decreases (& C)

- Rate of Interest Effect = Rise in price level --> Some people sell financial assets (such as gov bonds) to obtain more money to pay higher prices --> Increased supply of gov bonds --> Gov bonds price falls --> Increase in interest rate paid by bond --> Increased savings --> Reduced C&I

Consumption Factors

DR WARC

- Distribution of Income - improve = ↑C

- Real disposable Income - rises = ↑C

- Wealth - rises = ↑C

- Average Propensity to Consume - higher = ↑C

- Rate of Interest - rises - ↓C

- Consumer Confidence - higher = ↑C

Factors affecting how much of their income people save?

- Real interest rate on savings deposits (return on savings adjusted for inflation)

- Expectations of future income/job security (consumer confidence)

- Availability of credit - borrowing is dis-saving

- Taxation of saving

- Availability of savings institutions

Average Propensity to Save

(Savings/Disposable Income) x 100

Investment Factors

PC ATIT

- Profits (expectations & current) - increase = ↑I

- Capacity Utilisation - higher = ↑I

- Adequacy of Financial Institutions/Government Policies - more wiling & able to provide credit to firms = ↑I

- Technology Advances - ↑I

- Interest Rates - rise = ↓I

- Taxation - rise = ↓I

Accelerator Effect

A change in the level of investment in new capital goods is induced by a change in the rate of growth of national income or aggregate demand.

ie. Positive accelerator effect occurs when an increase in rate of growth of consumer demand leads to a rise in planned capital investment by businesses.

Capital Output Ratio

Ratio between the existing stock of fixed capital assets and the output a firm is producing.

= Capital/Output

Government Spending Factors

PES

- Budget Deficit - increases = ↑ GS

- Policy (fiscal policy) - expansionary = ↑ GS

- External Factors - anything that affects where government spends money on (e.g. wars, climate changes, environmental disasters)

- State of economy - better performing = ↓ GS

Expansionary Fiscal Policy

Government trying to increase AD (to stimulate economic growth) by increasing Government Spending, cutting taxes.

Expansionary Monetary Policy

Central bank trying to stimulate economic growth by lowering interest rates.

Government Budget Deficit

When government spends more money than it collects from taxes

Government Budget Surplus

When government collects more money from taxes than spends

Net Exports Factors

C FLEET

- International Competitiveness - more competitive = ↑ X-M

- Factor Endowment = country's stock of factors of production (CELL)

- Level of Demand in Domestic Economy - domestic demand high --> domestic producers can't meet --> domestic households & firms import more --> ↓ (X-M)

- Exchange Rate - higher = ↓ (X-M)

- External Factors

- Tariffs = more = ↑ (X-M)

- Interest Rates = higher = ↓ (X-M)

Trade Surplus

Positive X-M. More exports than imports

Trade Deficit

Negative X-M. More imports than exports