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Description
Flashcards by Amardeep Kumar, updated more than 1 year ago
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Created by Amardeep Kumar
over 9 years ago
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| Question | Answer |
| Define Aggregate Demand. | Aggregate demand (AD) is the total demand of consumers, firms and governments for final goods and services in an economy at a given time at all possible price levels. This is the demand for the GDP of a country. |
| What does the aggregate demand curve measure? | The aggregate demand curve therefore measures real National Output & Employment against the Price Level. |
| How is the AD curve drawn? | The demand curve is downward sloping to illustrate the inverse relationship between aggregate demand and price. |
| How does the inverse relationship determine the outcome of a rise and a fall in the price level? | A fall in the price level should in theory lead to a rise in Aggregate Demand and a rise in national output. A rise in the Price Level should in theory lead to a fall in Aggregate Demand and a fall in national output. |
| What are the 4 componenets of aggregate demand? | 1. Consumption spending (C) 2. Investment spending (I) 3. Government spending (G) 4. Trade (X-M) |
| Define consumption as a component of aggregate demand. | Consumption represents the total amount spent by consumers on finished goods and services regardless of where they are produced. In the UK, consumption represents 2/3rds of Aggregate Demand. |
| What are the 4 factors that determine consumption? | -Income -Wealth -Credit -Expectations |
| How does income affect consumption? | The income factor of the consumption component of aggregate demand is represented by Disposable Income. This is the amount of gross income consumers have left to spend after deducting taxes and adding benefits. |
| How is income calculated? | Disposable Income = Gross Income - Taxes + Benefits Income per capita = GDP / Population Real Income = Current Income adjusted for Inflation. |
| What is wealth and what is the key physical form for a person? | Wealth is a measure of the total physical and intangible assets owned by a person, firm or country. For an individual, property is the key physical form of wealth. |
| What wealth effects are likely to occur during a rise in property prices? | Households should in theory increase their consumption as the higher house price is likely to increase their confidence. They increase the mortgage of the property (equity withdrawal) to finance their higher spending. |
| What are the 3 types of credit? | 1. Secured Loans such as mortgages to purchase items such as property. 2. Unsured loans to purchase items such as cars. 3. Credit cards for anything else. |
| What are the 3 determinants for household borrowing? | 1. Disposable Income 2. Expectations 3. Interest rates - the cost that must be paid to the lender as a reward for borrowing their money. |
| How do interest rates affect aggregate demand? | Lower interest rates will encourage more borrowing and more consumption. Rising property prices will also increase borrowing and consumption. |
| What are expectations? | The are expectations that households have about the future, and usually forecast for Inflation, Interest rates and House prices. |
| How are future expectations likely to affect consumption? | -If households expect economic conditions to worsen they are likely to reduce consumption in order to build up savings. -If households expect economic conditions to improve they are likely to increase consumption. |
| Define savings. | Savings represent part of household disposable income that is not spent but saved in banks, investment funds and shares. Therefore, they are a withdrawal from the circular flow of income. |
| What is used to measure savings? | The savings ratio is used to measure the proportion of disposable income that is saved by households. |
| How do falling interest rates cause a decline in the savings ratio? | -Lower interest rates means that the cost of borrowing is lower, which also implies a lower reward to savers. -Lower interst rate should encourage higher consumption by households, leading to an increase in aggregate demand and higher output & employment. |
| How do falling levels of unemployment lead to a decline in the savings ratio? | -Falling levels of unemployment mean more consumers are in work and enjoying rising wages and salaries. -This allows them to increase their spending at the expense of saving. |
| How does the falling price of consumer durables cause a decine in the savings ratio? | -The price of consumer durables falls over time as improvements in technology and competition allow suppliers to cut prices. -A high proportion of spending on consumer durables will be financed using credit thus leading to a rise in borrowing and a fall in saving. |
| How does a wider availability of credit cause a fall in the savings ratio? | -It is easier for consumers to obtain credit from banks and retailers. Online and in-store applications mean credit can be arranged at a short notice. -Job security and low interest rates encourages consumers to take on higher debt. |
| How do rising house prices cause a decline in the savings ratio? | -In the last ten year years, average house prices have more than trebled compared to previous decades. -This increases a consumers wealth and encourages them to increase both spending and borrowing. |
| What is positve equity and equity withdrawal? | -Positive equity exists when the property value exceeds the mortgage. -Equity withdrawal is where the homeowner re-mortgages their property to take out cash. |
| What is negative equity and when is it most likely to occur? | -Negative Equity exists when the mortgage value exceeds the property value. -This is most likely to occur when house prices fall, probably during an economic recession. |
| How does a recession lead to negative equity and a fall in real national income? | House prices are likely to fall meaning some households experience negative equity, and this discourages bank lending and consumer spending. This leads to a fall in AD, leading to a lower level of output & employment. |
| How does the use of credit in order to increase consumption have some negative consequences? | The rising level of consumer debt is a problem when it becomes unattainable. The recession is leading to rising levels of house repossessions and bankruptcies as unemployment means consumers don’t have the disposable income to afford repay their debts. |
| Define Investment. | Investment is the spending on capital goods such as factories, machinery, offices and stocks of materials which are use to produce finished goods and services to satisfy consumers. |
| What are the 2 types of capital? | Physical Capital represents investment in man-made things such as buildings, factories roads and machinery. Human capital represents investment in people through teaching and training. |
| What is gross investment? | This is the investment in any capital item such as a machine will have a limited life and will have to be replaced because it will get worn out through use or made obsolete by new technology. Gross investment includes the replacement of existing capital items. |
| What is net investment? | This is the spending on additional investment that is on top of what is needed simply to maintain the capital stock and so when an economist is talking about a rise in investment they are talking about a rise in net investment. |
| What are the 2 areas where investment takes place? | -Public sector investment is investment carried out by any government funded body and will include spending on schools and hospitals. -Private sector investment is spending on capital goods by firms such as a car manufacturer building a new factory. |
| What affect will investment have on the economy? | Investment will shift the PPF curve outwards, and shift the Aggregate Demand curve to the right, implying an increase in the productive capacity of the economy and higher output and employment. |
| How will the level of consumer demand affect investment? | Firms invest in order to produce consumer goods and make a profit in the process. Higher demand means firms can make higher profits which can be used to finance investment. |
| How will the rate of interest affect the level of investment? | The MEC curve shows that Investment has an inverse relationship with interest rate. This implies that a cut in interest rates should in theory result in higher levels of planned investment by firms. |
| How will a change in the cost of capital goods affect investment? | A fall in the price of capital goods has the effect of encouraging firms to increase investment spending. The cost of new technology is falling and should make it cheaper for firms to invest. |
| How can improvements in technology increase the level of investment? | Technological change should make capital goods more productive which means firms can produce more outputs from a given level of inputs. This has the effect of raising the profitability of an investment. |
| How will expectations and Business Confidence increase the level of investmet? | The more optimistic they are about the future the higher their level of investment, because they are more confident of recovering that investment and making a profit. Expectations may include interest and inflation rates, exchange rates and government spending. |
| How do government policies affect investment? | The UK government has spent £billions on new school and hospitals. However, it is firms who carry out this construction. Therefore, spending on education and health encourages firms to increase their investment in capital goods. |
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