Chapter 11: Aggregate Demand
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aggregate demand
the total amount of spending on goods and services produced in an economy during a period of time
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how is AD represented?
AD=C+I+G+X-M
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AD is made up of:
the combined spending of households on consumer goods+firms on investment goods and government expenditure (including current and capital spending)
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exports
spending by the rest of the world on domestically produced goods
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imports
spending by residents on goods and services from the rest of the world
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imports being higher than exports...
lead to a negative balance of trade in goods and services
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government expenditure does
excludes public spending on investment
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component: consumption
largest single component of AD
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consumption is...
the total planned household spending
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disposable income
determinant of cosumption
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average propensity to consume
the proportion of income that households devote to consumption
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calculating the average propensity to consume
household consumption (c) is £80 and disposable income (Y) is £100. avg propensity to consume is calc as C/Y= 80/100=0.8
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marginal propensity to consume (MPC)
the proportion of additional income that household devote to consumption
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marginal propensities to consume
consumption rises to 87 (c) and disposable income (Y) increases to 110. MPC is (87-80)/(110-100)=0.7
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marginal propensity to save (MPS)
the proportion of an increase in disposable income that households devote to saving
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disposable income
the income that households have to devote to consumption and saving, taking into account payments of direct taxes and transfer payments
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transfer payments
(a transfer payment is a redistribution of income and wealth (payment) made without goods or services being received in return.)
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determinant of consumption
wealth of a household
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wealth
(the accumulation of assets) instead of flow of INCOME received by households per period
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house prices increase...
households may be more prepared to consume rather than save, having the security of their property
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general state of the economy...
households may spend more if they have confidence in the future. (so falling house prices or a period of recession would make households lose confidence
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an rise in the rate of interest that raises the cost of borrowing...
may deter consumption
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at the same time though, it may encourage saving
as the return on saving (instead) is higher when the interest rate is higher
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rate of interest may also have an indirect effect on consumption
through its effect on the value of asset holdings ( eg high interest rate- high value of asset holdings)(low interest rate-
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consumption function
the relationship between consumption and disposable income; its position depends on the other factors that affect how much households spend on consumption (ceteris paribus-eg wealth and interest rates are assumed to be constant)
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interpreting the marginal propensity to consume
MPC IS 0.7- so for every add £100 of income received by households (£100x0.7=£70) would be consumer expenditure and the remaining £30 would be saved
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component: Investment
expenditure undertaken by firms to add to the capital stock
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investment
(leads to an increase in the productive capacity of the economy, by increasing the stock of capital available for production)
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capital stock is made up of
plant and machinery, vehicles and other transport equipment, and buildings, including new dwellings- which provide a supply of housing services over a long period
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firms are to replace
capital that has worn out
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overall state of the economy
if economy is going through a period of rapid growth and it's expected to continue, then firms are likely to be optimistic about the future prospects for demand for their products and will use this opportunity to gain profit (investing in capital gds
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on the other hand
when the economy heads into recession, firms may hesitate to invest in new capacity
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so confidence is important in
shaping their willingness to undertake investment expenditure
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Keynes argued that
"animal spirits" of firms would influence them
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this would be bad because
recession dampening firms' confidence in the future, would lead to investment expenditure to fall which will deepen the recession or at least delay the recovery
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international competitiveness is important when
firms are involved in exporting activity where a successful amount of demand for exports can offset the effects of low domestic demand
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in the case of a global recession that affects many economies simultaneously
dampening effects on confidence can be severe (as it's dealing with having confidence in countries that are importing)
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investment may be influenced by the government
by providing incentives (a payment to stimulate greater output) for firms to invest, in the form of tax concessions (so less tax on goods being produced)
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government may also use
regulation: to influence the pattern/location of investment (eg targeting EU funding towards parts of the country that have found it difficult to attract private investment)
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high rate of inflation
increases uncertainty about the future and may damen firms' expectation about future demand and so discouraging investment
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cost and availability of finance for investment
may also affect the amount of investment that takes place
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high interest rate and firms need to borrow to invest on goods
may be discouraged from spending if interest rate is too high
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access to credit
financial institutions (banks) should be prepared to lend and that they have funds available to lend
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government expenditure
regarded as independent of the variables in the model (-)
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parts of government expenditure tends to vary
with fluctuations in the level of the overall economic activity.
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e.g a period of recession
some workers lose out their jobs-claim JobSeeker's Allowance: which affects government expenditure. and unemployed workers also no longer pay income tax so government revenue falls.
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exports and imports
exchange rate between sterling and other currencies affect x+m as with other things being equal, an increase in the sterling exchange rate makes UK exports less competitive and imports into the UK more competitive
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volume of international trade
protectionist policies introduced by countries to protect their own industries
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tariff
tax on imports (so increases people buying from abroad)
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if UK inflation is high compared to elsewhere
this will tend to make UK exports less competitive and imports more competitive.
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demand for imports into the UK
depends partly upon the level of domestic aggregate income.
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demand for UK exports
will depend partly upon the level of incomes in the rest of the world.
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aggregate demand (AD) curve
the relationship between the level of aggregate demand and the overall price level; it shows planned expenditure at any given possible overall price level
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Other cards in this set
Card 2
Front
AD=C+I+G+X-M
Back
how is AD represented?
Card 3
Front
the combined spending of households on consumer goods+firms on investment goods and government expenditure (including current and capital spending)
Back
Card 4
Front
spending by the rest of the world on domestically produced goods
Back
Card 5
Front
spending by residents on goods and services from the rest of the world
Back
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