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AS Macro Revision Aggregate Demand


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AS Macro Revision Aggregate Demand

  1. 1. Aggregate Demand Year 1 Economics
  2. 2. Meaning and Measurement of Aggregate Demand • Aggregate Demand (AD) = • Total level of planned real expenditure on goods and services produced within a country in a given time period • The components of aggregate demand are: • Household spending on goods and services (C) • Gross Fixed Capital Investment Spending (I) • Value of the Change in Stocks (Inventories) (I) • Government Spending on Public Services (G) • Exports of Goods and Services (X) • (minus) Imports of Goods and Services (M) • GDP (expenditure-based) is the actual value of expenditure • Changes in AD are key to understanding fluctuations in a cycle e.g. recession and recovery, boom and slowdown stages
  3. 3. The Components of Aggregate Demand (AD) Source: HM-Treasury Databank Consumption (C) Government Spending (G) Investment (I) Exports (X) Imports (M) Year £m £m £m £m £m 2007 1,021 326 294 477 538 2008 1,016 333 281 485 528 2009 982 337 240 445 476 2010 987 337 254 472 518 2011 985 337 260 499 523 2012 1,000 345 262 502 539 2013 1,018 344 271 510 547 2014 1,044 349 294 512 560 2015 Consumption is the biggest component of aggregate demand
  4. 4. Growth of UK Aggregate Demand 2007-2015 Source: HM-Treasury Databank Consumption (C) Government Spending (G) Investment (I) Exports (X) Imports (M) Year Per cent Per cent Per cent Per cent Per cent 2007 2.8 1.2 5.3 -2.1 -0.8 2008 -0.5 2.0 -4.7 1.6 -1.8 2009 -3.3 1.2 -14.4 -8.2 -9.8 2010 0.5 0.0 5.9 6.2 8.7 2011 -0.1 0.0 2.3 5.6 1.0 2012 1.5 2.3 0.7 0.7 3.1 2013 1.7 -0.3 3.4 1.5 1.4 2014 2.6 1.6 8.6 0.5 2.4 2015
  5. 5. Aggregate Demand – A Contraction of AD General Price Level Real GDP AD = C+I+G+(X-M) GPL1 Y1Y2 GPL2 GPL3 Y3 A rise in the price level causes a contraction of AD
  6. 6. Aggregate Demand – An Expansion of AD General Price Level Real GDP AD = C+I+G+(X-M) GPL1 Y1Y2 GPL2 GPL3 Y3 A rise in the price level causes a contraction of AD A fall in the price level causes an expansion of AD
  7. 7. Understanding why the AD Curve Slopes Downwards Real incomes • As the price level falls, the real value of income rises and consumers are more able to buy what they want or need – this is known as the real balance effect Balance of trade • A persistent fall in the relative price of level of Country X could make foreign-produced goods and services more expensive, causing a rise in exports and a fall in imports – the trade balance will improve Interest rate effect • If price inflation is low and this leads to a reduction in interest rates, there is less incentive to save and a fall in interest rates may also cause the exchange rate to depreciate – helping to improve export sales
  8. 8. Shifts in the Aggregate Demand Curve (AD) General Price Level Real GDP AD1 GPL1 Y1 AD2 Y2 AD3 AD1 – AD2: Outward shift – will raise national output at all price levels
  9. 9. Shifts in the Aggregate Demand Curve (AD) General Price Level Real GDP AD1 GPL1 Y1 AD2 Y2 AD3 Y3 AD1 – AD2: Outward shift – will raise national output at all price levels AD1 – AD3: Inward shift – will reduce national output at all price levels
  10. 10. Examples of Shifts in Aggregate Demand Fall in AD Fall in net exports (M>X) Cut in government spending (G) Higher interest rates Decline in household wealth and confidence Increase in AD Depreciation of the exchange rate Cuts in direct and indirect taxes Increase in house prices Expansion of supply of credit + lower interest rates
  11. 11. Changes to Monetary Policy • Changes in official monetary policy interest rates • Change in the supply of money and credit • Change in the value of a country’s exchange rate Changes to Government Fiscal Policy • Changes in the level of direct / indirect taxes • Changes in government (state) spending • Changes in government (fiscal) borrowing Business and Consumer confidence • Planned capital investment spending by businesses • Consumer confidence and retail spending Key Causes of Shifts in Aggregate Demand
  12. 12. External Shocks to Aggregate Demand Many unexpected events cause changes in demand, output and employment. These events are called external “shocks” A large rise or fall in the value of the exchange rate A recession, slowdown or boom in one or more of a nation’s key trading partner countries A slump in the housing market / construction sector of a country An event such as the Global Financial Crisis which caused a fall in the supply of credit available to businesses and households A large change in commodity prices for a country that is a commodity exporter
  13. 13. Exports of Goods and Services (X) Relative Prices of exports in World Markets The exchange rate – a stronger currency makes exports more expensive Non-Price Demand Factors e.g. Design and Branding Strength of Aggregate Demand in Key Export Markets Exports are goods and services sold to other countries. Exports are an injection into a nation’s circular flow of income and spending Many factors affect the level of demand for a nation’s exports – some of these are shown on the left
  14. 14. UK Car Export Markets The UK remains a large exporter of cars to the rest of the world. Here is data on the main export markets for UK manufacturers Cars exported from the United Kingdom (UK) 2014 (per cent of total exports) EU 53.1 China 11.5 US 8.8 Russia 6.8 Turkey 2.1 Australia 1.9 Japan 1.4 Israel 1.3 Switzerland 1 South Korea 1 Canada 1
  15. 15. The Net Trade Balance (X-M) and Aggregate Demand The net trade balance is measured as the value of exported goods and services minus the value of imported products A trade surplus means that X>M – therefore aggregate demand (AD) will increase A trade deficit means that M>X – therefore aggregate demand will fall If X=M, then the trade balance is zero, external trade will have a neutral effect on AD 0 50 100 150 200 250 300 350 400 450 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 TradebalanceinbillionU.S.dollars Balance of Trade for China 2000-2014
  16. 16. • Public sector debt is owed by central and local government and by public (state-owned) corporations • Debts owed by state-owned banks are included in the figures for national debt • Private sector debt is owed by private businesses and households. • Companies / businesses may have borrowed to finance investment (corporate sector debt) • Households have loans for example credit card debt, retail store card debt and mortgages on properties • Financial debt is also part of the private sector – this is the outstanding (unpaid) debts of banks and financial corporations - for example the level of bad debts on loans to businesses and to the housing market Public and Private Sector Debt
  17. 17. • In 2013, household and non- financial firms’ debt amounted to 208% of UK GDP – down to levels last seen in mid-2007, but significantly higher than they were a decade ago (170pc of GDP) and 15 years ago (128pc of GDP). • The UK private debt/GDP ratio is high by historical and international standards, and well above the 160% level used by the EU Commission as a threshold for gauging imbalanced debt to income levels for EU member states. The Scale of Debt in the UK Economy
  18. 18. UK Household Debt Relative to Disposable Incomes 60 70 80 90 100 110 120 130 140 150 160 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 Short-term Loans Long-term Loans Stock of outstanding loans to households, % of households’ disposable income • Short term loans include outstanding debt on credit cards • Long term loans include mortgage debt
  19. 19. • Debt acts as a constraint on future spending power • Millions of people in the UK are saddled with many thousands of pounds of debt and the interest payments on this debt reduces their effective disposable income • Commercial banks also have high debt and this restricts their ability to make fresh loans to businesses and households who want to borrow. This can limit business investment • The economy can be at risk with a high debt-to-GDP ratio • If price deflation happened, falling consumer prices and incomes would make the debt problem worse in real terms • When nominal interest rates rise even by just a modest amount, then many households – especially mortgage payers - are at risk and can struggle to meet repayments. This could cause a slowdown or a possible recession in the housing market. Consequences of Debt for an economy such as the UK
  20. 20. Aggregate Demand Year 1 Economics