Chapter 18: Aggregate demand and the circular flow of income

Define aggregate demand

What is national expenditure ?

What are the different sectors of the economy ?

What is the aggregate demand equation?

If any of the components of AD change, what happens to aggregate demand ?

Define consumption

Aggregate consumption does not include what ?

What is saving ?

What is investment ?

Who makes saving decisions and who makes investment decisions ? (usually)

Give an exception to the idea that firms only make investment decisions.

If a business were simply to stores profits as a cash reserve, what would they be doing ?

Whenever members of households make decisions about whether or not to spend on consumer goods, they are simultaneously deciding what ?

A determinant of consumption is also a determinant of what ?

What are the main factors influencing consumption and saving ?
(7 marks)

Define interest rate

The rate of interest rewards savers for what ?

The higher the interest rate, the greater the what ?

At any particular income level, the amount saved will increased while what rises and what falls ?

Keynes believed what about the relationship between rising aggregate planned consumption and rising income ?

In the 1930s, Keynes argued what about interest rates and aggregate saving and consumption decisions ?

Keynes lack of enthusiasm for the effectiveness of interest rates led him to focus on what as the main determinant of consumption and saving decisions ?

Keynes argued for what as the most important single determinant of consumption ? He believed that consumption is also largely a function of it/

What is the the Keynesian consumption function equation ?

Draw a graph showing Keyne's theory of consumption

Explain what autonomous consumption is
What is the value of autonomous consumption determined by ?

Explain what Income-Induced consumption is
- What rises at a faster rate than income ?

Explain how saving can be positive or negative

The current level of income in a particular year may have much less influence on what ?

What may have more influence on a person's planned consumption ?

What is 'non-contractual' saving ?

What is contractual saving ?

Give some examples of contractual saving

How do people plan their contractual saving ?

What generally has little effect on the contractual savings that are regularly contributed to pension schemes and to purchase life insurance policies ?

Define Wealth

Which is a stock and which is a flow in terms of wealth and income

What are the 2 main forms of wealth asset that people own in the UK and the USA ?

What generally happens if conumers' wealth increases ?

An increase in house prices usually causes home-owners to do what ?
Why ?

What is the main household wealth asset in the UK ?

How do rising house prices influence economic behaviour among owner-occupiers of houses ?

How do falling house prices influence the economic behaviour of house owners ?

What was the impact of the stock market crash in 2000 centred on the collapse of the share prices of dot.com and high-tech companies ?

In the summer of 2007, what event caused share prices to fall at the time of the financial crisis in the USA ?

In 2008, what 2 main factors ushered in a recession in the USA and is other countries such as the UK ?

What was the impact of borrowers not being able to repay their loans/ interest on banks ?

What was the result of banks haulting lending to each-other ?

What were the main impacts of a lack of mortgages in the housing market ?

What is a state of consumer confidence closely linked to ?

When consumer optimism increases, households generally do what ?

What is the likely impact of a fall in consumer optimism ?

Why do Governments try to boost consumer and business optimism ?
How do they do it ?

If the government is optimistic about the future and people believe there are good grounds for this optimism, how are the general public likely to be ?

How much consumer confidence dissipate ?
(2 marks)

What other aspects of monetary policy affect consumption ?

If credit is available easily and cheaply, then what is likely to happen to consumption ? Why ?

What is the likely impact of tight monetary policy ?

Explain the link between the financial crisis in 2007 and 2008 and tight monetary policy reducing consumption.

Explain how the distribution of income influences consumption and saving.

Uncertainty caused by fears of rising inflation has what affect on saving and consumption ?

What is the opposite effect of expectations of rising future inflation ?

If people expect property prices to appreciate at a rate faster than general inflation, people may make what decision ?

If the real rate of interest is low or negative, people will often decide to buy what things in preference to saving through the purchase of financial assets?

Why does speculative demand for housing occur ?

Define the personal savings ratio

What is the equation for the personal savings ratio ?

What is a household saving ratio ?

What does the personal sector consist of ?

Why are economists interested in how much of their incomes people plan to save and to consume in the near future ?

What is generally used as an indicator of what people wish to do in the future in terms of consumption and saving ?

Why is the personal saving ratio used as an indicator of future plans ?

Between the end of 1996 and early 2008, what happened to the UK household savings ratio ?

The household savings ratio bottomed out at what % before the beginning of the recession ?

When does negative saving occur ?
What is this called?

After early 2008, the household savings ratio recovered to around what % in 2009 and 2012 ?

What is one of the factors affecting household savings ? What is the effect ?

What usually happens to savings ratios in recessions ?

What factors may override an increase in the savings ratio ?

What is the equation for total savings ?

What was the UK savings ratio in Q3 2014 ?

Why do savings ratios tend to rise in recessions ?

What is the paradox of thrift ?

In a recession, a sharp rise in the savings ratio means what happens consumer spending ?

In Keynesian economics, a rise in the savings ratio gives reason for what governmental actions ?

If the savings ratio rises, what is the effect on government spending and borrowing ?

What are the main benefits of a high savings ratio ?
(2 marks)

What are the main problems with a high savings ratio ?

What are the main problems with a low personal savings ratio

What is investment ?

How can firms and the government invest in human capital ?

Is capital or investment a stock concept or a flow concept ?

What is the national capital stock

How do we measure the flow of investment ?

What are the 2 parts of a country's gross investment ?

Explain what replacement investment is

Explain what net investment is

Along with technical progress, net investment is one of the engines of what ?

Investment in physical capital goods can be two types:

What are the 2 main determinants of investment in fixed capital ?

If a firm is expected an investment to yield a return of 8% on average for each year of the investment's expected future life, and the cost of borrowing the funds to finance the investment is 6%, is the investment worthwhile ? Why ?

Draw a typical marginal efficiency of capital curve

What does the marginal efficiency of capital curve ?

Define planned investment

Define actual investment

What happens if firms fail to sell as much as they want to ?

Define autonomous investment

Define induced investment

On a marginal efficiency of capital curve, the equilibrium level of aggregate investment is determined on the graph at what point ?

Explain how worthwhile the investment is at the equilibrium level

All investments to the left of the equilibrium level of aggregate investment are said to be what ?

Investments to the right of the equilibrium level are what ?

How is a collapse in investment shown by an MEC curve ?
What is the effect ?

Other than expected future rates of return and the rate of interest, what are some other determinants of investment ?
(5 marks)

When the price of capital rises, (prices of capital goods or rates on interest rise) what do firms do in the long-term ?

If the price of capital goods or the interest rates fall, firms switch to what methods of production ?
What is the impact on investment ?

Define technical progress

What is the impact of technical progress of a machine's business life ?

What is a machine's technical life ?

A sudden burst of technical progress may cause firms to do what long before the equipment's technical life is over ?

Many investments in fixed capital are what type of time period ?

Why may long-term investments in fixed capital goods be difficult to finance ?

The growth of what has emerged to provide an important source of medium to longer term finance ?

How can governments finance investment projects ?

In the past, the UK governments have provided investment funds to rescue jobs in what type of industries ?
Why is this viewed as poor choice on governments behalf ?

Why might government ministers and their civil servants make bad investment decisions ?

What is the accelerator ?

The size of the accelerator depends on what ?

The accelerator theory stems from what assumption about firms production and investment ?

If output grows by a constant amount each year, why will firms invest in exactly the same amount each year ?

When the rate of growth of output accelerates, what happens to investment and why ?

When the rate of growth of output decreases, what happens to investment ?

What does a capital-output ratio of 4:1 mean ?

The accelerator, or the accelerator coefficient is also known as what ?

State the equation showing the accelerator principle

With a capital-output ratio of 4:1, holding the assumption that current net investment in fixed capital depends on the change in income or output in the previous year.

1) In year 2013, Net investment is £40 billion, current income is 4x(£100bn) and last year's income is £90bn.
- In 2014, current income increases by £10bn.
- What will happen to net investment in 2014 ?

If income grows by the same amount each year, what happens to net investment ?

If income growth speeds up or ACCELERATES, what happens to net investment ?

If income growth slows down or decelerates, net investment will ?

As firms adjust stock of capital to the desired level, relatively slight changes in the rate of growth of income or output cause what ?

You can use the accelerator to explain what ?

Draw a circular flow of income model

Households supply what in exchange for goods and services produced by firms ?

These real flows generate what ?

What is the AD formula ?

Saving in the circular flow of income is an example of what ?

What are investment in the circular flow of income ?

What does the circular flow of income show ?

What are the 3 main withdrawals from the circular flow of income ?

What do withdrawals lead to ?

What are the main injections into the circular flow of income ?

Define equilibrium national income

When equilibrium national income occurs, national income is tending neither to ?

If the withdrawal exceeds injection, the resulting net leakage of spending from the circular flow causes what to occur ?

Savings can be either hoarder or the funds being saved can be ?

When may planned saving end up equaling planned investment ?

Where planned saving ends up equaling planned investment, what is the outcome of national income and the level of income?

If planned savings is greater than planned investment, the national income or output circulating around the economy is in what ?

Explain what a disequilibrium in national income is where planned saving is greater than planned investment

If planned saving by households exceeds planned investment by firms, there is a danger of what occurring to cause the economy to shrink into recession ?

John Maynard argued what about household savings and the level of income or output circulating in the economy

How does the economy end up in a recession if savings are not lent to finance spending ?

What was the belief of many of Keynes's opponents on deficient aggregate demand?

Why do low interest rates cause people to save less and for firms to invest more in new capital goods ?

Keynes believed what about the process of interest rates bringing about equality between saving and investment ?

Keynes believed that the level of income does what when planned leakages of demand from the circular flow of income exceed planned injections of demand into the flow ?

According to Keynes, what is the major cause of recessions ?

Define a Closed Economy

Define open economy

In an extended circular flow model, national income equilibrium, tending neither to rise nor to fall, is shown by what equation ?

S+ T + M > I + G + X

What does this equation show ?

In keynesian analysis, a net leakage causes what to happen to the equilibrium level of national income ?

S + T + M < I + G + X
what does the equation show ?

In keynesian analysis, what happens to the equilibrium level of national income ?

Explain how changes in the rate of interest affect consumption and saving
(12 marks)

Explain the meaning of the circular flow of income (12 marks)

Do you agree that recessions are always caused by a collapse in aggregate demand ? justify your answer (25 marks)

'Lending your savings to a bank is always good; hoarding your savings by keeping them in a safe is always bad.' Discuss the extent to which you agree or disagree with this view.
(25 marks)