AD and AS

• Aggregate Demand (AD)


  The total spending in an economy within a particular time period
• Aggregate

  
  

  total/all combined
• AD equation: C + I + G + X - M
• AD curve

  
  

  AD curve shows the negative relationship between the price level and the level of real expenditure in the economy.

  Price level: the average of the prices of all the products produced in the economy.

  We measure the price level by using the CPI (a basket).

  
  

  Conclusion: A movement along the AD curve is caused by a change in the price level
• AD and consumer spending

  Increased consumer spending increases AD
• AD and saving

  Increased saving decreases AD
• AD and investment

  Increased investment increases AD
• AD and government spending

  Increased government spending increases AD
• AD and net exports

  Increased net exports increases AD
• AD curve

  • Negative relationship between price level and real expenditure in the economy
• The horizontal axis of the AD curve shows the value of GDP, not the quantity demanded
• Why Y is used to indicate GDP

  Y is used to denote income in economics and GDP is a measure of national income
• If the price level fell


  This would lead to an extension of AD
• Reasons for the downward slope of the AD curve

  • Real balance effect - higher prices reduce consumer purchasing power
  • Trade effect - higher domestic prices reduce exports and increase imports
• Shifts of the AD curve

  1. Rightward shift - increase in AD

  2. Leftward shift - decrease in AD
• Factors causing a shift in the AD curve

  Changes in any of the components of AD (C, I, G, X-M)
• Consumption (C)


  Expenditure by consumers on goods and services
• Investment (I)

  Expenditure by firms on new machinery and other capital goods
• Government (G)

  Expenditure by the government on the provision of goods and services
• Exports (X)

  Expenditure by foreign individuals, firms and organisations on domestic goods and services
• Imports (M)


  Expenditure by domestic individuals, firms and organisations on foreign goods and services
• Net Exports (X-M)


  The difference between exports and imports
• Average propensity to consume (apc)


  The proportion of income that is spent
• Average propensity to save (aps)


  The proportion of income that is saved
• Income = Consumption Spending + Saving
• Marginal propensity to consume (mpc)


  The proportion of a change in income that is spent
• Marginal propensity to save (mps)


  The proportion of a change in income that is saved
• Relationship between mpc/mps and income level


  Higher income groups have lower mpc and higher mps. They will save most of any increase in income as they already have their desired standard of living.

  Lower-income groups have higher mpc and lower mps. They will spend most of any increase in income as they want to improve their standard of living.
• Effect of income tax changes on consumption

  Decreases in income tax increase disposable income and consumption
• Effect of interest rate changes on consumption

  Increase in interest rates has an income effect (reduces discretionary income) and a substitution effect (encourages saving over spending)
• Effect of financial markets on consumption

  Rising asset prices (shares, property) increase wealth and consumption
• Effect of consumer confidence on consumption

  Decreased confidence leads to increased saving and reduced consumption
• Effect of demographic trends on consumption

  Aging population tends to have lower consumption and higher saving
• Investment (I)


  • Affected by business confidence, company profitability, and taxes
• Effect of interest rates on investment

  Higher interest rates reduce investment as it is more costly to borrow
• Effect of exchange rate changes on net exports

  Depreciation increases net exports, appreciation decreases net exports
• Effect of domestic and foreign booms/recessions on net exports

  Domestic recession increases net exports, foreign recession decreases net exports
• an appreciation of r/e


  Leads to a fall in net exports
• UK exports become more expensive


  Reduces foreign demand for them
• UK citizens will have to pay fewer £ to get foreign currency


  Makes imports much cheaper and this increases our demand for them