2.2 Aggregate demand

• What does aggregate demand measure?

  Total spending on goods and services
• What is the formula for aggregate demand?

  AD = C + I + G + (X - M)
• What are the components of aggregate demand?

  • Consumption
  • Investment
  • Government spending
  • Net trade
• What are the reasons for the downward sloping curve?

  • The real balance effect
  • International trade effect
  • The interest rate effect
• What does movement along the demand curve cause?

  Expansion or contraction in demand
• What is movement along the demand curve caused by?

  Change in price
• What do shifts in AD lead to?

  Increase or decrease in real GDP
• What causes a shift on the AD curve?

  Components of AD changing
• What causes a decrease in AD?

  • Fall in exports
  • Cut in government spending
  • Higher interest rates
  • Decline in household wealth
• What causes an increase in AD?

  • Depreciation of exchange rate
  • Cuts in indirect and direct taxes
  • Increase in house prices
  • Expansion of supply of credit
  • Low interest rates
• What is consumption?

  Spending by households on goods and services
• What factors affect consumption?

  • Interest rates
  • Consumer confidence
  • Wealth effects
• What is disposable income?

  The household income available from employment, private pensions, investments and welfare benefits after direct taxes
• What are the determinants of consumption?

  • Disposable income
  • Interest rates
  • Levels of personal debt
  • Levels of personal wealth
  • Confidence
• What is savings?

  any disposable household income that is not used for consumption
• What is investment?

  An increase in the capital stock
• What is gross investment?

  Total expenditure on new capital goods
• What is net investment?

  New additions to capital stock after taking into account the fall in value of capital assets
• What is depreciation?

  The fall in value of capital assets due to wear and tear and obsolescence
• What is the formula of gross investment?

  Gross Investment = Net Investment + Depreciation
• What is the formula for net invetsment?

  Net Investment = Gross Investment - Depreciation
• What are the determinants of investment?

  • Rate of economic growth
  • Business expectations and confidence
  • Keynes and 'animal spirits'
  • Demand for exports
  • Interest rates
  • Access to credit
  • The influence of the government
  • Government regulations
• What is government spending?

  The spending by the government departments and local councils on goods and services like schools and hospitals
• What are the influences of government expenditure?

  • Trade cycle
  • Fiscal policy
• What is the trade cycle?

  Refers to fluctuations in GDP around the long-run trend in economic growth
• What is the fiscal policy?

  The use of government expenditure and taxation to influence the level of economic activity
• What is net trade?

  The difference between the value of exports and the value of imports
• What are the influences of the net trade balance?

  • Real income
  • Changes in exchange rates
  • Changes in the state of the world economy
  • Degree of protectionism
  • Non price factors
• What are the types of fiscal policies?

  • Discretionary fiscal policies
  • Automatic stabilisers
• What are discretionary fiscal policies?

  When governments deliberately manipulate total spending in the economy by changing their own level of spending
• What are automatic stabilisers?

  Automatic fiscal changes as the economy moves through stages of the business cycle
• How does the real balance effect cause a downward sloping curve?

  • When price levels rise, the purchasing power of cash assets fall which leads to a decrease in the demand for real output
• How does the international trade effect cause a downwards sloping curve?

  • A rise in price level cashews a decrease in the international competitiveness of goods causing a decrease in demand for exports and a rise in demand for imports causing a contraction in AD
• How does the interest rate effect cause a downward sloping curve?

  • Assuming a constant money supply, a higher price level results in an increased demand for money making interest rates rise reducing consumption and investment causing a contraction in AD
• How do interest rates affect consumption?

  • Higher interest rates increase the incentives to save as the reward is greater
• How does consumer confidence affect consumption?

  • If individuals and workers are nervous about the future, they may be inclined to save more of their income in the event of wage cuts, wage freezes or redundancy
• How does the wealth effect affect consumption?

  • If prices are rising quickly, then the real value of savings is eroded, so the incentive to save reduces
• How does disposable income affect consumption?

  • Higher levels of disposable income will normally lead to greater levels of consumption as individuals can afford more goods and services
• How do interest rates affect consumption?

  • 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 doe levels of personal debt affect consumption?

  • If individuals have low levels of personal debt they will normally consume more as less disposable income is diverted to repayments