Chapter 4. Revision.

Aggregate Demand and Aggregate supply and their interaction.

Aggregate Demand: is the total demand for goods and services produced in an economy at a given price level and in a fiven price period. This planned expenditure on domestic output comes from households,firms,the government and foreignes. It is made up of consumer expenditure, investment, government spending and net exports(x-m). So AD= C+I+G+(x-m)

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

Consumer expenditure: spending by households on consumer products.

Investment: spending on capital goods.

Government spending: spending by the central government and local government on goods and services.

Exports: products sold abroad.

Imports: products bought from abroad.

Net-exports - the value of exports minus the value of imports.

The components of aggregate demand.
1) consumer expenditure is also known as consumption. It is for most counrties the largest component of AD. It is spending by households on items such as clothing, food and insurance.
2)Investment is the volatile component of AD. Spending on capital goods, such as delivery vehicles, machines and office buildings.
3) Government spending is spending by the central government and local government on, for example, education,health care and the police service.It doesn't include transfer payments and job seeker's allowance and pensions.
4)net exports add forefnes' spending on the country's goods and services and deduct spending by the country's population on imports. If a country has a trade surplus, with exports being greater than imports, then adding net exports to C+I+G will increase aggregate demand. In contrast, the existence of a trade deficit would mean that aggregate demand would be lower than domestic demand.

Definitions:
Trade surplus: the value of exports exceeding the value of imports.

Trade deficit: the value of imports exceeding the value of exports.


Consumer expenditure.
There are range of influences on how much households spend.They include:
1) Real disposable income: this is the main influence on consumption. Richer households and richer economies tend to spend more in total than poorer ones.The average propensity to consume. a city banker's spending APC(spent money/disposable income) may be lower than teacher's spending APC.

2)Wealth:the more health people have(home,savings account),the more they tend to spend.Wealth can be spent and can be used to borrow against. It also results in greater consumer confidence.

3)Consumer confidence and expectations: when consumer are confident about their future,theu also spend more.

4) the rate of interest: Usually a fall in rate of interest will lead to more spendings by consumers.

5) The age of people: usually old and young people tend to spend more than middle-aged group.

6)Inflation:if people expect prices to rise in the future, they may spend their money now.

Definitions:
Disrtibution of income: how income is shared out between households in a country.
Inflation: a sustained rise in the price level
Average propensity to consume:the proportion of disposable income spent. in is consumption divided by disposable income.
net savers:people who save more than they borrow.
Wealth: a stock of assets.(property,shares,money held in savings account)

SAVINGS.
Influences on savings include:

1)real disposable income:average propensity to save rises.

2)the rate of interest:rise in it increases the reward for saving and so usually encourages people to save more.

3)confidence and expectations:people and firms are usually tend to save more,if they are not confident about their future.

4)saving schemes:when people agree to save a certain amount on a regular basis in insurance and pension schemes.

5)Government policies:a decision by the government to introduce tax-free saving schemes will encourage people to save more.

6)the age of a people: young people tend to spend more and the middle-age group of people usually save more than they spend.

Definitions:
dissave: spending more than disposable income
Savings ratio: savings as a proportion of disposable income


INVESTMENT

influences on investment include:
1)changes in real disposable income:if real disposable income increases,it is mean that demand for goods and services will also rise.

2)expectations:firms more likely to invest,if they are confident about their economic future.

3)capacity utilisation:firms are also tend to invest more if they are operating near to full capacity.

4)current profit levels:high profit levels can encourage investment in two ways:they provide finance to invest and they are likely to contribute to firms' optimism about the future.

5)corporation tax: if there is a cut in tax,firms will have more money,therefore more investment.

6)the rate of interest:a rise in interst rate likely will decrease the investment.lower demand for shares will reduce their price level and so decrease the funds that firms can raise for investment.

7)advanced technology:firms can invest money in machinery,in purpose to incsease the profit or quality of the products.

8)price of capital equipment:a reduction in capital equipment may also rise investment.


Definitions:

capacity utilisation:the extent to wich firms are using their capital goods.

corporation tax: a tax on firm's profits

ratained profits:profit kept by firms to finance investment.

unit cost: average cost per unit output.



Government spending.

1)the government's view on the extent of market failure and its ability to correct it.

2)the level of economic activity in the economy can influence government spending.

3)a desire to please the electorate. voters can put pressure on the government to spend money improving education, health care and transport infrastructure.

4)war, terrorist attacks and rising crime or their threat can also increase government spending.



Netexports

1)real disposable income abroad: a rise in income abroad is likely to result in more exports being sold.

2)real disposable income at home:a rise in income at home may result in a fall in exports.

3)the domestic price level: the value of exports may fall and the value of imports rise if domestic price level rises relative to the price levels in the country's trading partners.

4) the exchange rate:a fall in a country's exchange rate will reduce the price of exports and raise the price of imports.

5)government restrictions on free trade: a country's net exports may rise if other countries' governments remove trade resrtictions.



Definitions:
Real GDP: GDP after inflation
Gross domestic product(GDP): the total output of goods and services prodused in a country.
exchange rate:the price of one currency in terms of another currency.


The relationship between aggregate demand and the price level.

AD is inversly related to the price level. a rise in the price level causes a fall, or contraction, in aggregate demand and a fall in the price level results in a rise, or extension, in aggregate demand.
There are three effects wich explain why the AD curve is downward sloping:
1)the wealth effect:a rise in the price level reduces the purchasing power of wealth and so causes aggregate demand to contract.

2)the rate of interest effect: a fall in the price level will reduce the interst rate and cause an extention in AD due to higher consumption and investment.

3)the international trade effect: a rise in the price level assuming no change in foreign prices and the exchange rate will make the country's goods less internationaly competitive.This wold cause households and firms to buy more from foreign producres and less from domestic producers. Net exports would fall and aggregate demand would contract.


Definition
Government bond: a financial asset issued by the central or local government as a means of borroing money.


Aggregate supply

AS:is the total output of goods and services that producers in an economy are willing and able to supply at different price levels in a given time period.


Definitions:
Productivity: output,or production, of a good or service per worker per unit of a factor of production in a given time period.

Macroeconomic equlibrium: a situation where aggregate demand equals aggregate supply and real GDP is not changing.

Privatisation: transfer of assets from the publuc sector to the private sector.



Macroeconomic equlibrium.
if AD would be more than AS, there would be a shortage of goods and services.
The excess AD would encourage them to expand their output. The surplus AD may also push up the price level, depending on the leve of capacity.
AS exceeding AD would also lead to pressures that would move the economy back to eqilibrium.

The circular flow of income.
it is a model that seeks to explain how the economy works and how changes in AD occur.
In practice, not all the income that is earned is spent. There are also additional forms of spending that don't arise from the circular flow. income that is not spent on domestic output is said to leak out of the circular flow. THere are three leakages:taxes,savings,imports. Leakages reduce AD. In contrast, injections increase AD,they are:investment,government spending,exports.


Definitions.

Circular flow of income:the movement of spending and income throughout the economy.

Factor services:the services provided by the factors of production.

Leakages:withdrawals of possible spending from the circular flow of income.

Injections:additions of extra spending into the circcular flow of income.

Multiplier effect: when adding injections into the economy results in the greater rise in national income.



Multiplier effect.
occurs because when people spend money, that expenditure becomes the income of those who sell them the goods. they,in turn, will spend some of the money they recieve. so there is knock-on effect, with AD rising by more than the initial amount.


Changes in Aggregate demand.
1)if the economy is initially operating with considerable spare capacity, an increase in AD is likely to raise the output of the economy, reduce unemployment and leave the price level unchanged.

2)A rise in AD may increase both output and the prise level. This outcome occurs if either the economy moves from a position of significant spare capacity to one where there are shortages of resources or it moves from one where shortages are already being experienced to one where there are even greater shortages.

3)if the economy is already operating at the full employment level,with no spare capacity, an increase in AD will be purely inflationary.


Changes in Aggregate supply.
an increase in AS occuring when the economy is at, or close to, full capacity will raise the output of the economy and lower price the price level.
There is the possibility that an increase in AS may have no impact on the economy. This situation wouls occur if the economy was initially operating at a low level of output with a high level of unemployed resources. in this case the increase in AS will increase potential output but not actual output and will leave the price level unchanges.


Changes In AD and AS.
Over time both AD and AS increase. also investment and consumption raise. AS increases due to technologies and improved education.If increases in AS can match increases in AD, the economy can enjoy higher output without encountering inflationary pressures.If AD grows more rapidly than in productive capacity, inflation will ocur.Overheating is experiencing higher output, but this rise is coming at the cost of inflation and will not be sustainable unless AS increases at a more rapid rate.

Output Gap.
An output gap is said to exist when an economy is not producing at full capacity.A negative output gap occurs when the economy's actual output is below its potential output.A positive output gap arises when an economy's actual output is above that of its potential output.For a short time an economy may be able to rpoduce more if workers work overtime, some people who are not usually in the labour force enter it,and machinery is used flat out.It will be possible to sustain this output in the long run, unless AS increases.


Definitions.

Overheating: the growth in AD outstripping the growth in AS, resulting in inflation.

Output gap: the difference between an economy's actual and potential real GDP.

Trend growth: the expected increase in potential output over time.