S14: Aggregate Demand
Objective 1:
Distinguish between demand and aggregate demand (AD).
Define demand-
the willingness and ability to buy a product at a given
time.
Define aggregate demand-
Total spending on goods and services in a period of time at
a given price level.
Microeconomic demand
curve
Macroeconomic demand curve
p
average
price level
GDP price deflator AD
Quantity Real output=real
gdp=national income=y
Objective 2: Define
and describe the components of aggregate demand. *think GDP expenditure approach here.
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Consumption
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The total spending by consumers on domestic goods and services
·
Durable Goods-any good that’s going to be
consumed over a period of time.
·
Non-Durable Goods- are goods such as rice,
toilet paper and newspapers that are used immediately or in a relatively
short period of time.
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Investment
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Defined as the addition if capita stock. Investment is carried out by
the firms and there are two types: 1. Replacement investment- firms spending
to maintain the productivity if their existing capital.
2. induced investment occurs when firms spend on capital to increase
their output to respond to higher demand in the economy.
·
Capital Stock- includes all goods that are
made by people and are used to produce other goods or services such as
factories, machines, offices or computers.
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Government spending
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Governments at a variety of levels (federal, state/provincial) spend
on a wide variety of goods and services; health, education, law and order,
transport, social security, housing and defence.
Depends on gov. policies.
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Net exports (X-M)
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Export revenues minus import expenditures (the figure can be either
positive (when revenues exceed expenditure) or negative (when expenditure
exceeds revenues))
If net exports is pistive it will add to AD, if it is negative, it
will reduce AD
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Objective 3- Explain
the determinants of the components of AD.
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What
causes changes in Consumption?
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1
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Changes in income-
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When national income goes up, aggregate demand goes up.
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2
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Changes in interest rates-
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When interests rates goes up, aggregate demand goes down
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3
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Changes in wealth-
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An increase in wealth results in a rightward shift of the AD curve
Wealth goes up demand up
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4
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Changes in expectations /consumer confidence-
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Optimism about the economic future results in more spending now:
ogton measure by consumer confidence index
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5
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Household indebtedness-
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The extents to which households are willing and able to borrow money
affect consumption. If interest rates are low and it is easy to borrow and
spend increasing AD. If interest rates rise household will have to spend more
to re-pay their loans and mortgages and spending will drop.
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What
causes changes in Investment?
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1
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Changes in Interest Rates
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When it goes u demand goes down
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2
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Changes in level of National Income
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If it goes up demand goes up
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3
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Technological Changes
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When it goes up demand goes up
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4
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Changes in expectations /business confidence-
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When it goes up demand goes up
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What
causes changes in Government Spending?
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1
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Changes in policy-
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Dependent on policy
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What
causes changes in Net Exports?
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1
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Changes in domestic national income-
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An increase in Y puts pressure to decrease
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2
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Changes in foreign income-
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When foreign incomes rise rightward preasrure is placed on AD because
foreigners buy exports.
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3
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Relative currency values-
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If domestic currency has a high value leftward pressure is placed on
AD because to foreigners goods/services seem expensive.
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4
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Trade policies
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Protectionist policies put leftward pressure on AD whereas free-trade
policies place rightward pressure on AD.
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5
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Relative inflation rates among trading partners
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Hight inflation rates make goods seem expensive to foreigners.
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Determinants at a Glance
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C
∆s in Y
∆s in i (interest rate)
∆s in consumer confidence
∆s in wealth
Household indebtedness
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I
∆s in Y
∆s in i (interest rate)
∆s in business confidence
Technological changes
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G
∆s in government policies
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X-M
∆s in Y
∆s in foreign Y
∆s in exchange rates
∆s in trade policies
Relative inflation rates
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Objective 5: Illustrate shifts of the AD
curve.
AD shifts right/left/uncertain
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1
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Congress cuts taxes
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right
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2
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Interest rates rise
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left
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3
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Government spending to increase; president promises no increase in
taxes.
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right
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4
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Consumer confidence jumps
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right
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5
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Stock market collapses
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left
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6
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Productivity rises for fourth straight year
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right
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7
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Value of the pound increases sharply
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left
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Objective 7: Explain how governments can
use monetary and fiscal policy to alter the level of AD in an economy.
Fiscal policy- the set of governments policies relating to
its spending and taxation rate.
Direct taxes-taxes on income
Indirect taxes- taxes on goods and services
Money supply= refers to the amount of money in circulation
at a given period of time
Interest rate= Base rate/discount rate/prime rate-the price
charged to borrow money. The rate charged by the central bank to other banks
Expansionary fiscal policy
(Encourage consumption-shift AD right)
Lower income tax to increase disposable income
Lower corporate taxes to encourage investment
Increase government spending to improve or increase public
services
Contractionary fiscal policy
(Discourage consumption-shift AD left)
Raise corporate taxes
Decrease government spending
Expansionary monetary policy
Decrease the interest rate
Increase the money supply
Decrease the reserve ratio
Buy back governments bonds
Contractionary monetary policy
Increase the interest rate
Decrease the money supply
Increase the reserve rate
Sell gov bonds.
Objective 8- Explain the Nature of a government budget
Government budget-refers to the total spending by all levels
of government and is split into three categories
1.
Capital expenditure- includes spending that adds
the capital stock of the economy, ie. Upfrading ahighway or school
2.
Current expenditure- on going spenind such as
purchases of textbooks or wages to
publice sector employees
3.
Transfer payments-
Gov revenue comes from
Taxes- direct income
Tariffs- taxes on imported goods
Profits- or sales of nationalized businesses
Rent- of gov owned buildings or land
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Governments lay out their national budgets
yearly showing their expected revenues and expenditure this is called the
fiscal stance
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Budget surplus- when governments earns more than
it spends
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Budget deficit- when governments spends more
than it earns
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Balanced budget- when governments earning equal
what they spend
To finance or run a budget deficit the government musr
borrow money from
a)
Household
b)
Firms
c)
Foreign countries
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To do this they sell gov bonds
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People buy bonds as as a form of saving; they lend money to the
government and are eventually paid back along with extra payment
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The national debt is the sum of budget deficits
over time.
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