Aggregate demand and aggregate supply and their interaction

Aggregate demand and aggregate supply and their interaction

1. Aggregate Demand: the total demand for a country's goods and services at a given price level in a given time period

   • Consumption: spending by households on consumer products
     • influences
       • real disposable income= avg propensity to consume:prop of disp income that is spent. as disp income increases, prop of disp income spent decreases
       • wealth=if youre wealthy, the wealthier you are, more likely to spend meaning that you have higher consumer confidence
       • interest rate=cost of borrowing(less likely to borrow if high payback), reward for saving, net savers(save>spend, high interest beneficial for them
       • population structure=young and elderly tend to spend more of their disposable income
   • Government Spending: spending of central govt on public goods and services
     • influences
       • economic activity=recession(increased gs to encourage spending), boom(wont spend), expansion(dont need to spend)
       • war terrorism/crime=increased spending to defend activity
       • level of govt intervention=corrects market failure; autocracy, laissezfaire, democracy
       • political agenda=campaign is more spending to look good
   • Investment: spending by businesses on capital goods and services
     • influences
       • real disposable income=too high=sign to businesses to invest more on capital goods. but=if sustainable demand,people save instead,if firms have spare
       • business confidence=businesses would want to invest during expansion and recovery. cant invest at peak and trough as you dont know when youve hit it
       • capacity utilisation=extent to which businesses are using their capital goods. low=lots of spare capacity>low investment rate
       • taxes=income,VAT,corporation. cut in corporation tax increases amnt of profit firms can keep>increases investment
       • interest rate=if HIGH: increases opportunity cost of investment, more expensive to borrow,affect expected return,reduce demand for shares
       • technology=invest to increase efficiency of production. to produce products more cheap/better quality
       • capital equipment=reduction in price of equipment>increases investment
   • Net Exports: exports minus imports
     • influences
       • disposable income=increased income>increased spending power>imports go up>net exports decrease>trade deficit>AD decreases
       • exchange rate=rise in exchange rate will result in a fall in net exports (SPICED/WPIDEC)
       • govt restrictions on free trade=country's net exports increase if other countries govt remove trade restrictions.

2. Multiplier effect:the process by which any change in a component of aggregate demand results in a greater final change in real GDP

   • when one persons's spending becomes another's. this results in AD rising more than the initial amnt

3. Aggregate Supply: total amount of goods and services that producers are willing and able to supply at a given price level in a given time period

   • if spare capacity is high, lots of raw materials so unemployment level decreases
   • spare capacity decreases as its being used up-so few raw materials available. demand for extra workers decreases.
     • AS=becoming inelas as cost of production is rising, so price of goods/services has to rise in order to make profit
   • spare capacity is low as well as raw materials>demand for extra workers decreases and AS=inelast. cost of prof still increase despite no supply.
   • Short run=period of time where atleast 1 factor of production is assumed to be in fixed supply(unchangeable) >is temporary.
   • Long run=period of time where all factors of production are variable >is permanent.

4. Circular flow of income: movement of spending and income in an economy/ money circulating arnd economy.

   • factors of production (land, labour, capital, enterprise) are things required to make products going from households-->firms
   • factor incomes (wages, rent, interest, profit) are returns received from fop going from firms back to households
   • leakages= when households income doesn't all flow back to firms as expenditures on govt spending. e.g. savings, imports, tax.
   • injections=when outsiders invest extra money into an economy to expand output