Aggregate demand

• What is the definition of aggregate demand?

  The total demand for all goods and services in an economy at any given price level over a period of time.
• What are the components of aggregate demand?

  • consumption (C)
  • investment (I)
  • government spending (G)
  • net exports (X-M)
• What is the formula for aggregate demand?

  AD=C+I+G+(X-M)
• What does the X and M stand for in the AD formula?

  X=exports

  M=imports
• What is the biggest proportional section of AD?

  Consumption
• What is meant by price level?

  An average of prices in an economy.
• What does a change in price level on the AD curve lead to?

  A movement along the AD curve.
• What causes a shift in AD?

  A change in the AD components.
• What is the effect of falling real incomes in terms of AD?

  As the price level rises, the real value of income falls and consumers are less able to buy what they want or need.
• What is the effect of blalance of trade in terms of AD?

  A persistent rise in the price level of country X could make foreign-produced goods and services relatively cheaper, causing a fall in exports and a rise in imports.
• What is the effect of interest rates in terms of AD?

  If the price level rises, this causes inflation and a possible rise in interest rates, which then has a deflationary effect on consumer and government spending.
• What causes a contraction in AD?

  A rise in the price level leads to a contraction in AD.
• What causes an expansion in AD?

  A fall in the price level leads to an expansion in AD.
• What does an increase in business confidence that has led to more investment lead to on the AD curve?

  A shift outwards in AD.
• What does contractionary fiscal policy (a decrease in government spending and an increase in taxation) lead to on the AD curve?

  A shift inwards in AD.
• What does an increase in the price of commodities lead to on the AD curve?

  An increase in the price level.
• What does an increase in employment lead to on the AD curve?

  A shift outwards in AD.
• What causes a fall in AD?

  • fall in exports
  • cut in government spending
  • higher interest rates
  • decline in household wealth
• What causes an increase in AD?

  • depreciation of the exchange rate
  • cuts in direct and indirect taxes
  • increase in house prices
  • expansion of supply of credit + lower interest rates
• What determines the level of consumption in a household?

  • disposable income
  • interest rates
  • levels of personal debt
  • levels of personal wealth
  • confidence
  • consumer confidence
• How does disposable income determine the level of consumption in a household?

  c

  • higher levels of disposable income will normally lead to greater levels of consumption as individuals can afford more goods and services.
  • disposable income will change depending upon, for example, tax or wage rates
• How do interest rates determine the level of consumption in a household?

  • lower interest rates will normally increase consumption as saving becomes less attractive, loans become more affordable and individuals with variable rate mortgages see monthly disposable income increase.
• How do levels of personal debt determine the level of consumption in a houshold?

  • if individuals have low levels of personal debt e.g. credit cards or loans they will normally consume more as less disposable income is diverted to repayments.
• How do levels of personal wealth determine the level of consumption in a household?

  • individuals with higher levels will tend to consume more as they can borrow funds against the value of assets e.g. their house.
• How does confidence determine the leve of consumption in a household?

  • if individuals have confidence in their short, medium, and long term economic prospects, it is likely that they will increase their spending,
  • this is often linked to their employment prospects or job security.
• How does consumer confidence determine the level of consumption in a household?


  • Consumer confidence surveys measures a range of consumer attitudes, including forward expectations of the general economic situation and households’ financial postitions, and views on making major house hold purchases.
• What is the definition of marginal propensity to consume (mpc)?

  The proportion of one additional unit of income that is spent.

  a.k.a. The change in consumer spending following a change in income.

  The remainder is said to have been saved (mps)
• What are the changes in household spending?

  • durables
  • semi-durable goods
  • non-durable goods
  • services
• What do durables consist of?

  Spending on household goods and vehicles, photographic, communications and other recreational equipment, therapeutic appliances and valuables.
• What do semi-durable goods include?

  Clothing and footwear, household textiles and some household appliances, aw well as games, toys and hobbies.
• What do non-durable goods consist of?

  Food and drink, household maintenance, and utilities, fuel and items for recreation and culture (including newspapers, garden plants and flowers and pet related products).
• What do services comprise of?

  Actual and imputed rentals for housing, transport, health, cultural and communications services, as well as restaurants, accommodation and financial services.
• What is Household Consumption Expenditure (HHFCE)?

  An estimate of household spending.
• What is the relationship between savings and consumption?

  
  

  • whilst not a component of AD, the level of saving in an economy has a direct impact upon the level of consumption, and hence, AD.
  • In economics, any disposable household income that is not used for consumption is said to have been saved.
• When does saving occur?

  When people decide to postpone their consumption until a future time.
• What is saving?

  Household disposable income that is not spent .i.e. it is deferred spending.
• What are some examples of ways that money can be saved?

  there are many ways ranging from accounts in banks and building society accounts to savings in pensions and the rock market.
• What is meant by disposable income?


  Income after taxes and benefits.
• What is the savings ratio?

  The percentage of disposable income saved rather than spent.
• What is an example of the saving ratio?

  annual income=$25000

  saved=2500

  savings ratio=10%