DP IB Economics: HL 3.2 Variations in Economic Activity (AD & AS) Notes

Aggregate Demand (AD)

Definition: Total demand for all goods and services in an economy at a given average price level.
Expenditure Approach: AD = C (Consumption) + I (Investment) + G (Government Spending) + (X - M) (Net Exports).
Components:
Consumption (C): Total spending by households on goods and services.
Investment (I): Total spending on capital goods by firms.
Government Spending (G): Spending by the government that includes salaries, public goods, etc., excluding transfer payments.
Net Exports (X-M): The difference between exports and imports.
Importance of Components: Different countries have varying components contributing to AD; for example:
In Sweden: Government spending is 53% of AD; in the UK: 25% of AD.
A 1% increase in consumption or government spending impacts economic growth more significantly than a 1% increase in net exports.

Characteristics:
Downward sloping; as the average price level decreases, aggregate demand increases.
Movements along the Curve:
Caused by changes in the average price level.
Increase in price level shifts the curve left, signifying a contraction.
Decrease in price level shifts the curve right, indicating an expansion.
Shifts in the AD Curve:
A shift occurs due to changes in non-price determinants influencing consumption, investment, government spending, or net exports:
- Right Shift: Increase in any component of AD.
- Left Shift: Decrease in any component of AD.

Consumer Confidence: Affects spending; if confidence is high, consumption increases.
Interest Rates: Higher rates discourage spending, while lower rates encourage it.
Wealth and Income Tax: Increased wealth typically leads to more consumption.
Indebtedness: High levels of debt can restrict consumption due to higher repayments.
Future price expectations: Anticipated price increases can increase current consumption.

Interest Rates: Lower rates encourage borrowing for investment.
Business Confidence: Higher confidence leads to more investments.
Technology: Advancements can enhance productivity and incentivize investment.
Corporate Indebtedness: High levels of debt can restrict new investments.

Political Priorities: Government focus influences spending patterns.
Economic Goals: Fiscal policies can redirect expenditure towards key sectors like infrastructure.

Trading Partners' Income: Changes in income abroad affect exports; higher incomes mean higher exports.
Exchange Rates: Currency appreciation/depreciation impacts the price competitiveness of exports and imports.
Trade Policies: Protectionist policies usually reduce imports but might increase exports.

Definition: Total supply of goods/services produced at specific price levels in the short-run.
Characteristics: SRAS curve is upward sloping due to increasing production costs at higher output levels.
Movements: Similar to AD, movements occur due to changes in average price levels affecting output.
Shifts: Shift in SRAS occurs due to changes in costs of inputs or productivity.

Classical View: LRAS is vertical; economies self-correct to full employment in the long run.
Keynesian View: LRAS is L-shaped; economies can remain below full employment without government intervention.

Short-Run Equilibrium: Occurs where AD intersects SRAS.
Long-Run Equilibrium: For classical economics, long-run equilibrium constantly returns to full employment, adjusting price levels accordingly.

Inflationary Gap: When real GDP exceeds potential GDP; economies overheated.
Deflationary Gap: When real GDP is below potential GDP; indicates recession.

Fiscal Policies: Government adjustments in spending and taxes to influence economic activity.
Monetary Policies: Central bank adjustments to money supply/interest rates affect AD and ultimately economic growth.